When our founders started their own business, they kept hearing that the right structure could save a fortune in taxes. What they could not find was anyone who would explain how, or actually set it up. That experience is a big part of why Claremore exists.
Entity structure is still one of the most common places we find savings for clients. It is also one of the most misunderstood. Here is a plain-language look at one of the most common questions we get: should my business be taxed as an S corporation?
Your entity and your tax classification are not the same thing
Many owners form an LLC and assume that settles it. But an LLC is a legal structure. How it is taxed is a separate choice.
A single-member LLC is taxed like a sole proprietorship by default, and a multi-member LLC like a partnership. In both cases, all of the profit generally flows to the owners and is subject to self-employment tax, on top of income tax.
An eligible LLC or corporation can elect to be taxed as an S corporation instead. That election changes how your profit is taxed, without changing your legal entity.
How an S corp can save money
With an S corp, owners who work in the business are paid in two ways:
- A salary, run through payroll, which is subject to payroll taxes just like any employee’s wages.
- Distributions of remaining profit, which are generally not subject to self-employment or payroll taxes.
That split is where the savings come from. Instead of paying self-employment tax on all of your profit, you pay payroll taxes only on your salary.
The savings do not come from a loophole. They come from paying yourself correctly, and documenting it.
The catch: reasonable compensation
The IRS expects S corp owners who work in the business to pay themselves a reasonable salary for the work they do, generally in line with what you would pay someone else to do the same job. Paying yourself an unrealistically low salary to maximize distributions is one of the most common reasons S corps draw scrutiny.
Setting a defensible salary takes judgment. It depends on your role, your industry, your hours and your company’s profitability, and it should be documented and revisited as the business changes.
The real costs of an S corp
An S corp election is not free, and those costs should be part of the decision:
- Payroll. You will need to run payroll for yourself, with withholding, filings and payroll tax deposits.
- A separate tax return. The business files its own return each year, in addition to your personal return.
- Cleaner bookkeeping. Owner expenses, reimbursements and distributions need to be tracked carefully.
- State considerations. Some states treat S corps differently or charge their own taxes and fees.
When it tends to make sense
There is no single profit number that makes an S corp the right choice. In our experience, it starts to make sense when:
- Your business is consistently profitable, not just having one good year.
- Your profit is meaningfully higher than a reasonable salary for your role.
- You are prepared to run payroll and keep clean, monthly books.
- The projected tax savings comfortably exceed the added costs.
It may not make sense if profits are small or unpredictable, if you plan to sell or restructure soon, or if other parts of your tax picture would be affected in ways that offset the savings.
Timing matters
An S corp election generally needs to be filed within a set window near the start of the tax year it applies to, and there are rules for late elections. If you are considering a change for next year, the fall is the right time to run the numbers and prepare.
Not sure if your structure fits? Entity classification is one of the first things we examine in our Tax Strategy review. You get a written plan with estimated savings within 21 days, backed by our $20,000 savings guarantee.
This article is general information, not tax or legal advice. Every business is different, so talk with a qualified professional before changing how your business is taxed.
