The S-corp election, explained with actual numbers

Every profitable sole proprietor eventually hears the same advice at a barbecue: elect S-corp status and stop paying self-employment tax. The advice is half right, and the half that is wrong costs real money — so let us do the arithmetic properly.

The mechanics in one paragraph

As a sole proprietor, every dollar of profit bears self-employment tax of 15.3% up to the Social Security wage base. As an S corporation, you split profit into a reasonable salary — which still bears payroll tax — and a distribution, which does not. The saving lives entirely in that second bucket.

Take a business earning $140,000 of profit. As a sole proprietorship, roughly $19,800 goes to self-employment tax. Elect S-corp status, pay yourself a defensible $70,000 salary, and payroll taxes fall to about $10,700. The gross saving is around $9,100 a year.

What the barbecue version leaves out

An S corporation must run actual payroll — filings, remittances, a W-2 — and file its own return. Between payroll service and the extra preparation, budget $2,500 to $4,000 a year. The net saving in our example is closer to $5,500. Still well worth it — but the break-even sits near $60,000 of profit, not at the first dollar.

The salary must also be defensible. The IRS looks hard at S-corp owners paying themselves $12,000 against $200,000 of distributions. A reasonable salary is what you would pay someone else to do your job; we document ours with compensation studies so the position survives an examination.

If your profit has crossed six figures and you are still on Schedule C, run the numbers — with the payroll cost included. It is a fifteen-minute conversation with your accountant, and it is exactly what our tax estimator upstairs is for.