LLC vs. S-Corp: Which Entity Saves Your New Business the MOST on Taxes?
Dec 02, 2025
The Smart Entrepreneur's Guide to Legally Saving Thousands on Self-Employment Tax
Starting your own venture is thrilling, but the first critical decision you make—choosing your legal structure—can determine whether you pocket a hefty bonus or send an extra five figures to the IRS every April.
You've likely narrowed your focus to the two powerhouses of small business: the Limited Liability Company (LLC) and the S-Corporation (S-Corp). They both shield your personal assets from business debts, but when it comes to taxes, one is the undeniable champion for a profitable, growing business.
This definitive guide breaks down the complex tax code into simple, actionable steps. We'll show you how one simple election allows you to legally slash the biggest tax burden facing new entrepreneurs: the 15.3% Self-Employment (SE) Tax.
The Core Concept: Distinguishing Legal Structure from Tax Status
Before we dive into dollars and cents, let’s clarify the fundamental difference between these two entities, which is the source of all the confusion (and the key to your savings):
1. The Limited Liability Company (LLC)
An LLC is a legal structure. Its primary job is to create a legal wall—a limited liability shield—between your business debts (like loans or lawsuits) and your personal assets (your home, car, personal savings). Every small business should start here for protection.
By default, the IRS treats a single-member LLC as a sole proprietorship.
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The Default Tax Pain: As a sole proprietor, you are subject to the 15.3% Self-Employment Tax on 100% of your net business profit. This is the money that funds Social Security and Medicare.
An S-Corp is a tax status or election. It is not a legal structure. The "S" comes from the Internal Revenue Code (Subchapter S).
Most savvy entrepreneurs form an LLC (for the legal protection) and then file paperwork with the IRS (Form 2553) to be taxed as an S-Corporation. This allows the business to keep the simple, flexible management structure of an LLC while gaining the huge tax benefits of the S-Corp designation.
Understanding the Enemy: The 15.3% Self-Employment Tax
For a successful small business owner, the Self-Employment Tax is the single largest tax burden outside of federal income tax.
When you work for an employer, they pay half (7.65%) of your Social Security and Medicare taxes, and you pay the other half. When you are self-employed in a default LLC (taxed as a sole proprietor), the IRS considers you to be both the employee and the employer, so you pay both halves, totaling 15.3%.
This is why a default LLC can be financially devastating as you become more profitable. If your business nets $150,000, you are paying over $22,950 in SE Tax alone!
How the S-Corp Legally Beats the SE Tax
The S-Corp tax election provides the legal mechanism to avoid paying the 15.3% SE Tax on all of your profit. It does this by requiring you to split your business income into two parts:
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Reasonable Compensation (W-2 Salary): You must pay yourself a reasonable salary for the work you perform. This portion is subject to payroll taxes (the equivalent of the 15.3% SE Tax).
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Owner Distributions (Profit): The remaining profit you take out of the business is called a distribution. By law, the IRS does not subject distributions to the 15.3% SE Tax.
This simple split is the key to keeping thousands of dollars in your pocket every year.
The Tipping Point: When the S-Corp Saves You Money
While the S-Corp offers the best tax advantage, it also comes with extra administrative hassle and cost. You must run a formal payroll system for yourself and typically pay more for professional tax preparation because you are filing a separate business return (Form 1120-S).
For a brand-new business, the initial savings might not cover these extra costs. This brings us to the crucial question of when to make the switch.
The Profitability Sweet Spot for S-Corp Election
The general consensus among accountants and tax professionals is that the S-Corp election becomes financially mandatory when your business consistently reaches a certain Net Profit threshold.
The Rule of Thumb: When your business’s net income (what’s left after all expenses, before paying yourself) is consistently over $60,000 per year, the 15.3% SE Tax savings on your distributions will almost certainly outweigh the added payroll and CPA costs. Some experts use a lower threshold, such as $40,000 or $50,000, but $60,000 is a safe benchmark to guarantee significant savings.
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For instance, if your business nets $100,000 and you pay yourself a reasonable salary of $60,000, you save the 15.3% tax on the remaining $40,000 in distributions. That's a minimum of $6,120 in tax savings—far more than the cost of a good CPA and a payroll service.
The Step-by-Step Entity Strategy
You don't have to be stuck in one structure forever. The smartest entrepreneurs follow a phased approach that maximizes simplicity first and then maximizes tax savings as they grow.
Phase 1: The Start-Up (Net Profit Below $60,000)
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Your Choice: Form an LLC (default tax status: Sole Proprietorship).
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Why: You get immediate, essential legal protection (limited liability) with the easiest tax filing method (Schedule C). The lower profits mean the 15.3% SE Tax burden is manageable, and it's not worth the cost and complexity of the S-Corp payroll system yet.
Phase 2: The Growth Phase (Net Profit Above $60,000)
- Your Choice: Keep the LLC legal structure and elect S-Corp tax status.
- How: You file IRS Form 2553 with the IRS.
- Why: This is the ultimate tax-saving maneuver. You retain the simple, flexible operating rules of the LLC while adopting the S-Corp’s ability to bypass the 15.3% Self-Employment Tax on your profit distributions. This pivot is where your business starts saving thousands of dollars every single year.
This phased approach ensures you are only taking on complexity when the financial reward is substantial. By the time you hit the $60,000 net profit mark, the S-Corp is the undeniable winner for your bottom line.
In the battle of LLC vs. S-Corp for tax savings, the winner is clear for a profitable business: The LLC that elects to be taxed as an S-Corporation.
While the basic LLC offers essential legal protection and ease of administration, the S-Corp election offers a legitimate, IRS-approved path to substantial tax avoidance on your profit distributions. This single strategy is the most powerful tool available to small business owners looking to grow their wealth and keep more of the money they earn.
Don't let tax complexity scare you away from this critical strategy. Talk to a CPA specializing in small business today to plan your S-Corp election and secure your financial future.
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