LLC vs. S-Corp for the $200K Owner: The Real Math

The S-corp election is oversold. Not wrong, oversold. Somewhere between a payroll company's sales page and a Facebook group full of people who elected in November for a business that cleared $60,000, the S-corp became a reflexive answer to a question nobody asked carefully. The real question is not "should I be an S-corp." It is "does the self-employment tax I save exceed everything the election costs me, in cash and in complexity." For the owner clearing $200,000 or more, the answer is usually yes. But the margin is narrower than the pitch, and the things that erase it are exactly the things nobody mentions when they are trying to sell you a payroll subscription.

Start from what actually happens when you make the election. An LLC taxed as a sole proprietorship (or a partnership) runs its net profit straight onto Schedule C or Schedule K-1, and that profit is subject to self-employment tax under §1401: 12.4% for Social Security up to the wage base, plus 2.9% for Medicare with no ceiling. For 2024 the Social Security wage base is $168,600, and it rises to $176,100 for 2025. Above the base, only the 2.9% Medicare portion keeps running, and once your earnings clear the §1401(b)(2) threshold ($250,000 married filing jointly, $200,000 single) the Additional Medicare Tax of 0.9% joins it. The S-corp changes the character of the income. You pay yourself a salary that runs through payroll and carries FICA, and the remaining profit passes through as a distribution that does not.

The savings come from the distribution, not the salary

The entire S-corp advantage lives in the gap between your salary and your total profit. That gap escapes the 2.9% Medicare tax (and the 0.9% surtax, if you are over the threshold), and if your salary is below the wage base, a piece of it also escapes the 12.4% Social Security tax.

Here is where the $200,000 owner matters. If your net profit is well above the Social Security wage base, most of your Social Security tax is already capped whether you are an LLC or an S-corp, because you hit the ceiling either way. So the marginal savings on the high end is mostly the Medicare math, not the full 15.3%. Take a consultant with $220,000 of profit who pays herself a $110,000 salary. The $110,000 of distribution avoids 2.9% Medicare, worth about $3,190, plus the 0.9% surtax on the slice above her threshold. The Social Security savings is smaller than it looks because a $110,000 salary is below the wage base, so she is still paying the 12.4% on most of what she would have paid it on anyway. The gross tax saving here is real, in the low four figures, but it is not the "save 15.3% on everything" number that gets quoted.

That is the part the pitch gets wrong. The 15.3% headline only applies to profit that would otherwise sit entirely below the Social Security wage base, which is precisely not the situation of the $200,000 owner. For high earners, the S-corp is a Medicare-tax play with a modest Social Security kicker, and you have to run your specific salary-to-profit split to know the number.

Reasonable compensation is the wall the whole thing runs into

Every dollar you move from salary to distribution is a dollar the IRS would rather see taxed. So the statute, and a long line of cases, requires that an S-corp shareholder-employee take "reasonable compensation" for services rendered before any distributions. This is not a soft guideline. In David E. Watson, P.C. v. United States (8th Cir. 2012), an accountant paying himself $24,000 while pulling roughly $200,000 out of the firm had his compensation recharacterized to $91,044, with back FICA, penalties, and interest. The court did not care what the S-corp math wanted the salary to be. It cared what the labor was worth.

There is no formula in the Code for reasonable compensation. The IRS looks at training and experience, duties and time devoted, comparable pay for similar services, and what a third party would charge to do the job. The practical consequence is that you cannot set your salary at the number that maximizes your tax saving. You set it at the number you can defend, and then the tax saving is whatever is left over. The more aggressive the split, the thinner your defense, and audit exposure on S-corp officer compensation is a known enforcement lane, not a theoretical one.

The costs that quietly eat the savings

An S-corp is not free to run, and the recurring costs are real cash. You now file Form 1120-S, a separate return with its own preparation fee, typically $1,200 to $2,500 depending on complexity. You run payroll, which means a payroll provider, quarterly Forms 941, annual Forms 940 and W-2, and state unemployment and withholding accounts. Payroll compliance carries its own penalty regime, and the §6672 trust fund recovery penalty makes missed payroll deposits personally collectible. Add bookkeeping that has to be clean enough to distinguish salary from distribution from loan, because commingling is how a "reasonable comp" audit becomes a "was this even respected as a corporation" audit.

Net it out. If your election saves you $4,000 in Medicare and Social Security tax, and the extra return, payroll, and bookkeeping cost you $2,500, your real benefit is $1,500. That can still be worth it. But it is not the number on the sales page, and for a business right at the threshold with a high defensible salary, the two figures can meet in the middle and cancel.

I worked with a freelance software developer, single, LLC on a Schedule C, who cleared about $205,000 and had elected S-corp status the prior year on a forum's advice, setting his salary at $60,000. That salary would not survive a glance: senior developers in his market bill north of $150,000, and he was the only person producing revenue. We raised his reasonable compensation to $145,000, which shrank his distribution and therefore his saving, then priced in the 1120-S, the payroll service, and the state filings he had been ignoring. The election still came out ahead, but by roughly $1,900 a year, not the five figures he had been promised. The lesson was not that the S-corp was wrong for him. It was that the honest number was one-fifth of the pitch, and he had been carrying payroll-penalty risk he did not know about to get it.

QBI and the state layer can flip the answer

The §199A qualified business income deduction complicates the comparison in a direction the pitch ignores. Your QBI deduction is generally 20% of qualified business income, and for taxpayers above the threshold ($191,950 single / $383,900 married filing jointly for 2024) it is capped at the greater of 50% of W-2 wages or 25% of wages plus 2.5% of qualified property. As an LLC sole proprietor, you have no W-2 wages, so above the threshold your deduction can be limited or, for a specified service trade or business, phased out entirely. As an S-corp, the salary you pay yourself creates W-2 wages that can support the wage-limited QBI deduction. That cuts both ways: the salary supports QBI but also reduces the QBI base, and the math is genuinely business-specific.

State tax adds another layer. Some states impose an entity-level tax or a minimum franchise fee on S-corps that a disregarded LLC does not owe. California's $800 minimum plus a 1.5% S-corp franchise tax is the standout, but it is not the only one. And the pass-through entity tax elections that many states now offer, which let owners work around the $10,000 SALT cap, sometimes favor one structure over the other. Before you elect, you price the federal saving, the QBI effect, and your state's specific treatment together, because any one of them can turn a winning election into a wash.

Sources

• IRC §1401 (self-employment tax rates), including §1401(b)(2) Additional Medicare Tax thresholds
• IRC §199A (qualified business income deduction) and the W-2 wage limitation
• IRC §6672 (trust fund recovery penalty)
• Social Security Administration, contribution and benefit base: $168,600 (2024), $176,100 (2025)
• David E. Watson, P.C. v. United States, 668 F.3d 1008 (8th Cir. 2012)
• IRS Form 1120-S, Form 941, Form 940, Form W-2
• IRS reasonable compensation guidance for S-corporation officers (fact-and-circumstances factors)