"Should my LLC become an S corp?" is one of the most common questions small business owners ask once their profits start to grow. The short answer is: sometimes. An S corp election can lower self-employment tax, but it also adds payroll, extra filings and real costs.
This guide walks through how an LLC is taxed by default, what changes with an S corp election, and the trade-offs to weigh for tax year 2026.
First, an LLC is a legal structure, not a tax category
A limited liability company is created under state law. For federal taxes, the IRS doesn't have a separate "LLC" category. Instead, an LLC is taxed under one of the existing classifications, based on default rules or an election you make.
Default classification
- Single-member LLC: treated as a "disregarded entity" for income tax. If you're the owner, you report business income on your own return, usually on Schedule C, much like a sole proprietor.
- Multi-member LLC: classified as a partnership. The LLC files a partnership return, and each member reports their share of income.
Under either default, the owners' share of business profit is generally subject to self-employment tax: 15.3% (12.4% Social Security plus 2.9% Medicare), with the Social Security portion capped at $184,500 of combined earnings for 2026.
What an S corp election changes
An eligible LLC can choose to be taxed as an S corporation by filing Form 2553. If it files Form 2553 on time and meets the other requirements, it doesn't need to file Form 8832 separately.
As an S corp, the business itself generally doesn't pay federal income tax. Profit still passes through to the owners. The big difference is how owners who work in the business get paid:
- Salary (wages): run through payroll, with Social Security and Medicare taxes withheld and matched.
- Distributions: the remaining profit, which isn't subject to Social Security and Medicare taxes.
That split is where the potential savings come from. It's also where the IRS pays close attention.
The reasonable salary requirement
The IRS says that payments by an S corporation to a shareholder-employee must be treated as wages to the extent they're reasonable compensation for the services provided. You can't pay yourself a token salary and take everything else as distributions.
Courts have looked at factors like:
- Your training, experience, duties and responsibilities
- Time and effort you devote to the business
- What comparable businesses pay for similar services
- What the business pays non-owner employees
- Whether profits come mainly from your personal work or from staff and equipment
The more the profit comes from your own services, the more of it should generally be paid as wages.
An illustrative example
This is a simplified illustration with round numbers, not a projection of what you'd save. It ignores state taxes, payroll costs, retirement contributions and other factors that change the result.
Say your single-member LLC earns $120,000 in net profit in 2026.
| Default LLC | LLC taxed as S corp | |
|---|---|---|
| Amount subject to Social Security and Medicare taxes | Net self-employment earnings from the $120,000 profit | Only the salary, say $70,000 (if that's reasonable for your role) |
| Rest of the profit | N/A | About $50,000 paid as distributions, not subject to those taxes |
| New costs | None | Payroll processing, payroll tax filings, a separate business return, possible state fees |
The payroll-tax difference on that $50,000 can be meaningful. But your actual result depends on what a reasonable salary is for your work, your state, and what the extra compliance costs you. If the salary has to be close to your total profit, there may be little left to save.
The cost and complexity trade-off
An S corp adds ongoing work that a default LLC doesn't have:
- Payroll: withholding, regular federal tax deposits, quarterly Form 941 filings, and W-2s each January.
- A separate business tax return (Form 1120-S), plus a Schedule K-1 for each owner.
- Cleaner books: you'll need to track wages, distributions and owner expenses carefully.
- Health insurance handling: premiums for a more-than-2% shareholder are reported as wages on the W-2 to keep the self-employed health insurance deduction.
For a business with modest or unpredictable profits, these costs can outweigh the savings.
Timing the election
Form 2553 must be filed no more than 2 months and 15 days after the start of the tax year you want the election to take effect, or at any time during the prior tax year. For a calendar-year business that wants S corp status for 2027, that means filing during 2026 or by mid-March 2027.
Missed the deadline? The IRS offers late-election relief (Rev. Proc. 2013-30) in many cases if you show reasonable cause, generally within 3 years and 75 days of the intended effective date.
To qualify, the business must also meet S corp rules, such as no more than 100 shareholders, only one class of stock, and only eligible shareholders (for example, no nonresident aliens).
The QBI deduction is now permanent
The One Big Beautiful Bill Act made the qualified business income (QBI) deduction permanent. It lets eligible owners of pass-through businesses (sole proprietors, partners and S corp shareholders) deduct up to 20% of qualified business income, subject to limits. Starting in 2026, the income phase-in range widens to $75,000 ($150,000 for joint filers), and there's a minimum deduction of $400 if you have at least $1,000 of QBI from an active business.
One thing to note: S corp wages paid to you don't count as QBI. Shifting profit into salary can shrink this deduction a bit, so it's part of the math.
Don't forget state taxes
States don't all treat S corps the same way. Some have their own S corp election rules, some charge entity-level taxes or annual fees, and some offer elective pass-through entity taxes. Your state's rules can change the outcome, so check with your state tax agency or a professional.
When it's worth getting help
The right answer depends on your profit level, what counts as reasonable pay for your role, your state, and how much payroll work you're willing to take on. A tax professional can model both options with your real numbers and help with the election and payroll setup if it makes sense.
Our business tax solutions team handles entity planning, and our bookkeeping and payroll service can run S corp payroll for you. Book an appointment when you're ready. This article is general information, not advice for your specific situation.
Sources
- IRS: Limited liability company (LLC)
- IRS: Instructions for Form 2553
- IRS: S corporation compensation and medical insurance issues
- IRS: Instructions for Form 7206 (self-employed health insurance deduction)
- IRS: Self-employment tax
- Social Security Administration: Contribution and benefit base
- IRS: 2026 Form 1040-ES (What's New: changes to QBID)
- IRS: Qualified business income deduction
General information, not tax advice. Tax rules change and depend on your situation. Figures are for tax year 2026 unless noted; confirm current amounts at IRS.gov or talk to a Stellar Tax professional before acting.