Skip to main content
Solo Operator Finance Hub

Methodology · Entity Structure

Entity structure methodology

Reviewed by · Last reviewed .

How we compute the LLC vs S-Corp decision on the LLC vs S-Corp Self-Employment Tax Decision Calculator: the FICA-on-salary-only mechanic, reasonable-salary administration burden, and the income threshold where S-Corp election starts paying.

Self-employment tax savings mechanic

LLC scenario (single-member or multi-member):
    SE tax owed on net Schedule C income:
        15.3% × min(net SE earnings, SS wage base)
        + 2.9% × any net SE earnings above SS wage base

S-Corp scenario (post-§1362 election):
    FICA owed on reasonable salary only:
        7.65% employer + 7.65% employee = 15.3% × salary
    Distribution portion: NO SE tax, NO FICA
    Per IRC §3121 + IRC §1366 pass-through

Annual SE-tax savings ≈
    15.3% × (net SE income − reasonable salary)
    (subject to SS wage base; reduces above the base)

Reasonable salary standard

Per IRC §3121 + IRS Rev. Rul. 74-44, S-Corp shareholders performing services must pay themselves a reasonable salary BEFORE taking distributions. The IRS standard: what would you pay an unrelated party to perform the same work? Practical benchmarks:

  • BLS Occupational Employment Statistics for the role + market
  • Industry-specific salary surveys (Glassdoor, Salary.com)
  • Rule of thumb: 40-60% of total business income for service businesses

Setting the salary too low triggers IRS scrutiny — they can re-characterize distributions as wages and assess back-FICA + penalties + interest.

Compliance overhead

  • Payroll service: $30-100/month at Gusto / Justworks / OnPay (~$500-1,200/year)
  • Form 1120-S annually + Schedule K-1 + Form W-2 + Form 941 quarterly + Form 940 annually
  • State-level franchise tax (CA $800/year minimum + LLC tax tiers; varies by state)
  • Tax-prep upcharge for S-Corp returns: $500-1,500/year above sole-prop
  • Bookkeeping discipline (S-Corp distributions vs salary need clean separation)

Real all-in compliance cost: $1,500-3,000/year depending on state + complexity.

Late election relief

Per IRS Rev. Proc. 2013-30, late S-Corp elections are commonly granted retroactive relief if (a) reasonable cause for late filing, (b) entity has been operating consistent with S-Corp status, and (c) all shareholders have reported income consistent with S-Corp tax treatment. File Form 2553 with reasonable-cause statement; relief typically granted for filings within 3 years of original deadline.

Sources

Back to methodology overview.