S-Corp vs Sole Proprietor — Which Saves You More?

The Core Difference — Where Your Money Goes

As a sole proprietor, every dollar of net profit runs through self-employment tax at 15.3%. You earn $130,000, you pay SE tax on all of it (after the 92.35% adjustment). Simple, predictable, and expensive.

As an S-Corp, your business pays you a salary — and that salary is subject to payroll taxes (the same 15.3%, split between the "employer" half and "employee" half). But any profit above your salary comes out as a distribution, and distributions are not subject to payroll or SE tax.

That's the entire concept. Salary = payroll taxes. Distributions = no payroll taxes. The savings come from the gap.

Here's the catch: the IRS requires that your salary be "reasonable." You can't pay yourself $10,000 and take $120,000 in distributions. The salary has to reflect what someone doing your job would actually earn. Setting it too low is the number one audit trigger for S-Corp owners.

So the real question isn't "should I be an S-Corp?" — it's "at my income level, is the payroll tax savings on distributions worth the added complexity and cost?"

Let's run the numbers.

Real Numbers — S-Corp vs Sole Proprietor at $130,000

Meet David and Susan. They file married filing jointly in Illinois and David's consulting business nets $130,000 after all business deductions. Susan doesn't have income. Here are both scenarios side by side.

Scenario A: Sole Proprietor

David keeps the default structure — sole proprietor, all income on Schedule C.

- Net self-employment income: $130,000 - SE tax calculation: $130,000 × 92.35% = $120,055 adjusted - SE tax: $120,055 × 15.3% = $18,368 - 50% SE tax deduction: $9,184 off AGI - AGI: $130,000 - $9,184 = $120,816 - Standard deduction (MFJ): $30,000 - Taxable income: $90,816 - Federal income tax: approximately $11,580 (across MFJ brackets) - Illinois flat state tax (4.95%): approximately $5,980 (on IL taxable income) - Total tax: approximately $35,928

Scenario B: S-Corp (with $75,000 Reasonable Salary)

David elects S-Corp treatment. Based on consulting market data, $75,000 is a defensible reasonable salary for his role and geography.

- S-Corp salary: $75,000 (subject to payroll taxes) - Payroll taxes on salary: $75,000 × 15.3% = $11,475 (employer + employee combined) - Distribution: $130,000 - $75,000 = $55,000 (NOT subject to payroll taxes) - AGI: $75,000 (salary) + $55,000 (K-1 income) - $5,738 (employer half of payroll taxes) = $124,262 - Standard deduction (MFJ): $30,000 - Taxable income: $94,262 - Federal income tax: approximately $12,023 - Illinois state tax: approximately $6,150 - Total tax: approximately $29,648

The Comparison

| | Sole Proprietor | S-Corp | |---|---|---| | Self-employment / payroll taxes | $18,368 | $11,475 | | Federal income tax | $11,580 | $12,023 | | State income tax | $5,980 | $6,150 | | Total tax | $35,928 | $29,648 | | Savings | — | $6,280 |

The S-Corp saves David and Susan $6,280 per year in payroll taxes. The income tax is slightly higher in the S-Corp scenario (because the 50% SE tax deduction is smaller), but the payroll tax savings far outweigh that difference.

But we're not done. There are costs.

The Costs Nobody Mentions

The $6,280 in gross savings doesn't go straight into David's pocket. Running an S-Corp costs money:

Payroll processing: David needs a payroll service to process his salary, withhold taxes, and file quarterly payroll returns. Cost: approximately $500-$1,200/year depending on provider (Gusto, ADP, or a CPA handling payroll).

Extra tax return: As a sole proprietor, David files one return (Form 1040 with Schedule C). As an S-Corp, he files Form 1120-S (the S-Corp return) plus his personal 1040 with a K-1. Most CPAs charge $800-$1,500 extra for the 1120-S preparation.

State compliance: Illinois charges a $75 annual report fee. Some states charge more — California's franchise tax board levies an $800 minimum franchise tax on all LLCs and S-Corps, regardless of income. David's state cost: approximately $75/year.

Registered agent: Most S-Corps need a registered agent for official correspondence. Cost: $100-$300/year (or free if David uses his own address, which isn't recommended for liability reasons).

Quarterly payroll tax deposits: The IRS expects payroll taxes deposited on a monthly or semi-weekly schedule, depending on the liability amount. This is an administrative burden, not a dollar cost, but it takes time.

Net Savings After Costs

| Item | Amount | |---|---| | Gross payroll tax savings | $6,280 | | Minus payroll service | -$750 (midpoint) | | Minus extra tax return | -$1,000 (midpoint) | | Minus state compliance | -$75 | | Minus registered agent | -$200 | | Net annual savings | $4,255 |

David still saves roughly $4,255 per year after all costs. Over five years, that's $21,000+ — real money. But it comes with ongoing administrative overhead.

When S-Corp Makes Sense (and When It Doesn't)

Not everyone benefits from an S-Corp. The math depends entirely on your income level.

Below $60,000 net SE income: The S-Corp rarely makes sense. Your payroll tax savings at this level would be roughly $2,000-$3,000 — and after $1,500-$2,500 in annual admin costs, you're left with savings of $500-$1,000. That's not worth the added complexity of separate tax returns, payroll processing, and quarterly compliance.

$60,000-$80,000: The gray zone. Savings exist but are modest after costs. Worth a conversation with your CPA, but not urgent.

$80,000-$100,000: The break-even zone for most people. Savings after costs start to become meaningful — $2,000-$4,000/year. This is typically where CPAs start recommending the switch.

Above $100,000: The S-Corp usually makes clear financial sense. At $130,000 (like David's example), net savings are $4,000+/year. At $200,000, savings can exceed $10,000/year after costs. The higher your net income, the larger the gap between salary and distributions, and the bigger the savings.

When it doesn't make sense regardless of income:

- You're in a state with high S-Corp costs (California's $800 minimum franchise tax eats into savings) - Your income fluctuates wildly year to year (S-Corp compliance is the same whether you earn $150,000 or $30,000) - You have a business partner and the ownership structure is complex - You plan to exit the business within 1-2 years (the setup costs won't be recouped)

The "reasonable salary" risk: The IRS has no official formula for determining reasonable salary. They look at industry standards, experience, geographic market, and what you'd pay someone else. Setting your salary too low — say, $30,000 when the market rate for your work is $75,000 — is the fastest way to get scrutinized. If the IRS reclassifies your distributions as salary, you owe back payroll taxes plus penalties and interest.

Use the S-Corp comparison calculator to run your specific numbers. For a broader look at how SE tax works, see the self-employment tax calculator. And for your full multi-income tax picture, the combined calculator brings everything together.