Here’s a breakdown of how both structures work under current (2025) IRS rules, what the pros and downsides are, and how to decide which is better for you.
Deciding whether to structure your business as an LLC or to elect S-Corporation tax status is one of the most important financial decisions you’ll make as a business owner — not just for liability protection, but for long-term tax efficiency and compliance. The right choice depends on how much your business makes, how much work you personally put in, and how much administrative complexity you're willing to manage.
While the LLC option offers flexibility and simplicity, S-Corp status can provide notable tax advantages. However, those advantages only pay off if everything is done correctly: payroll, reasonable compensation, and IRS filing deadlines all matter. Here’s a breakdown of how both structures work under current (2025) IRS rules, what the pros and downsides are, and how to decide which is better for you.
An LLC (Limited Liability Company) is primarily a state-level entity, but for federal tax purposes, it’s very flexible. According to the IRS, a domestic LLC can be treated as a disregarded entity (if you're the only member), or as a partnership (if you have more than one member), unless you make an election to be taxed differently.
An S-Corp is not a different legal entity (you can remain an LLC) — it's a tax status you elect with the IRS by filing Form 2553. If you make this election, your business is treated, for tax purposes, as an S corporation, which means:
The core tax benefit of electing S-Corp status is the potential to save on self-employment taxes (Social Security + Medicare) through a strategy of “reasonable salary + distributions.” Here’s how it works:
As an owner-employee who materially works in the business, you must pay yourself a salary. The IRS requires this to be “reasonable compensation” for the services you provide. What counts as “reasonable”? There’s no fixed number — it depends on your role, the business size, your duties, training, experience, how many hours you work, what someone else would be paid for a similar job, etc.
Because you're paying a salary, you run payroll. That means withholding for income tax, Social Security, Medicare, employer portion of FICA, and possibly unemployment taxes.
After you've paid salary, the remaining profits may be distributed to you (the shareholder) as dividends/distributions. Crucially, those distributions are not subject to self-employment tax in the same way as if all profit were taxed as self-employment income (because they’re not “earned income” in that sense).
If done right, this can result in significant tax savings. The more profit you can distribute (not as salary), the more you save on self-employment tax — but the bigger the risk if the IRS thinks your salary is unreasonably low.
Choosing S-Corp tax status can be a smart move — but not always. Here are the key indicators that it might pay off, especially under current tax law:
Electing S-Corp status comes with real requirements. Here’s what you’ll likely need to do:
One of the most common pitfalls is missing the deadline to file Form 2553, which is required if you want your business to be taxed as an S‑Corporation from a specific tax year. For a new entity, the election must generally be filed within 2 months and 15 days after the start of the tax year the election is to take effect. For existing businesses, the election can be filed during the preceding tax year or by the 15th day of the third month of the tax year of effect. If you miss that window, your S‑Corp status likely won’t apply for that tax year — and you may need to apply for late‑election relief under Rev. Proc. 2013‑30 (or its successor) which has its own requirements. The consequence? You may end up taxed under the default structure (LLC or C‑Corp) for that year, losing potential tax savings — so early planning and careful filing are essential.
If you elect S‑Corporation status and are an owner‑employee performing services, the IRS expects you to receive a “reasonable compensation” before non‑wage distributions are made. That means the salary you pay yourself should reflect what someone in a similar role, with similar duties and time commitment, would earn in the marketplace.
If you aggregate most of your profits as distributions and pay yourself a minimal salary, the IRS may reclassify those distributions as wages, triggering payroll taxes, penalties and interest. This risk grows if you don’t document how you determined your salary. To avoid this, research comparable salaries, keep records of your duties and hours, and update your salary if your role expands or profits grow.
Maintaining clear separation between your personal finances and your business finances is critical — especially when you’ve chosen S‑Corporation status (or even when you’re an LLC). If you co‑mingle personal and business accounts, run personal expenses through business accounts, or fail to maintain proper business books, you risk losing liability protection and complicating your tax reporting. For an S‑Corp, this confusion makes it harder to trace salary vs. distributions, and may invite IRS or state scrutiny. The remedy: open a dedicated business bank account, pay yourself via payroll from that account, document distributions clearly, and keep detailed financial records all year long.
Electing S‑Corporation status brings tax‑saving potential — but it also brings added responsibilities. You’ll likely need to run payroll (with withholding and employer taxes), issue W‑2s, file corporate tax returns (Form 1120‑S), maintain books and records, and possibly pay for additional accounting or legal support. If your business profit is modest, these additional costs may outweigh the tax savings of the S‑Corp structure. Before you make the election, run the numbers: estimate your tax savings from distributions, subtract the extra cost (payroll service, bookkeeping, professional fees), and decide if the net benefit justifies the extra complexity.
Federal rules might allow S‑Corporation status, but state‑level tax law can change the equation. Some states don’t fully recognize S‑Corp pass‑through taxation, impose entity‑level taxes or franchise fees on S‑Corps, or require specific filings or minimum taxes. If you don’t check your state’s rules, you may discover that the “savings” you expected are offset — or worse, erased — by state tax burdens. Always verify with your state department of revenue (or a qualified tax advisor) how S‑Corp status is treated in your state, and factor those costs into your decision.
Your business isn’t static — it grows, changes, and evolves. What made sense last year may not make sense this year. If profits drop, you change roles, bring on new shareholders, or your state’s tax law changes, the S‑Corporation structure may no longer deliver optimal savings. Failing to revisit your entity election annually means you miss opportunities to adjust, refine, or even revert to a simpler structure if that becomes more efficient. Make “entity review” part of your annual tax planning so you stay aligned with your business reality and tax environment.
Yes. A single-member LLC can file IRS Form 2553 to elect S-Corp tax status, as long as it meets the IRS’s eligibility criteria.
Not necessarily. If you are already an LLC, and you’re electing S-Corp status, you usually just submit Form 2553. Electing 2553 can also serve as your corporate classification election, under certain IRS rules.
There’s no one-size-fits-all salary. The IRS looks at your role, hours, experience, what similar roles pay, duties, and how much time you put into the business.
No — distributions (after a reasonable salary) are generally not subject to self-employment tax. But your salary is subject to FICA (Social Security and Medicare) via payroll.
You might be eligible for “relief for late election” under IRS procedures (e.g., Rev. Proc. 2013-30).
Yes. The S-Corp itself files Form 1120-S, and then issues Schedule K-1 to shareholders, which they use to report their share of income or loss on their personal returns.
Potentially. While S-Corp is a federal tax election, your state may have its own rules, fees, or taxes on S corporations. Always check your state’s department of revenue or chat with a tax professional at Vincere Tax.
Choosing between an LLC’s default pass-through treatment and electing S-Corp status isn’t a one-size-fits-all decision. S-Corp status offers realistic tax savings — especially when your business makes consistent profit and you're actively involved in its operations. But that benefit comes with added responsibilities: payroll, reasonable compensation, stricter recordkeeping, and annual filings.
You should run the numbers (salary vs. possible distributions, payroll costs, accounting support), understand the IRS eligibility rules, and make an informed decision. And yes — revisiting this choice every year is smart. As your business grows and evolves, the structure that made sense last year might not be ideal this year.
Being audited is comparable to being struck by lightning. You don't want to practice pole vaulting in a thunderstorm just because it's unlikely. Making sure your books are accurate and your taxes are filed on time is one of the best ways to keep your head down during tax season.
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This post is just for informational purposes and is not meant to be legal, business, or tax advice. Regarding the matters discussed in this post, each individual should consult his or her own attorney, business advisor, or tax advisor. Vincere accepts no responsibility for actions taken in reliance on the information contained in this document.
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