S-Corp Tax Savings Explained
How an S-Corp Saves You Money
As a Sole Proprietor or standard LLC owner, 100% of your net profit is subject to the 15.3% Self-Employment (SE) tax. However, the IRS allows LLCs to elect to be taxed as an S-Corporation. Under an S-Corp, you divide your profit into two buckets: a W-2 Salary and a Shareholder Distribution.
You only pay the 15.3% FICA/SE tax on the W-2 Salary portion. The remaining profit taken as a Shareholder Distribution is entirely exempt from SE tax, resulting in massive savings for high-earning freelancers.
The Reasonable Salary Requirement
Because distributions avoid SE tax, the IRS strictly requires S-Corp owners to pay themselves a "Reasonable Salary" before taking any distributions. A reasonable salary is defined as the market rate you would have to pay an employee to do your exact job. You cannot pay yourself $0 in salary and take 100% of your profit in distributions to avoid taxes.
Frequently Asked Questions
When is the right time to become an S-Corp?
Most CPAs recommend waiting until your freelance business hits an absolute minimum of $60,000 to $80,000 in net profit. Below this threshold, the extra costs of running an S-Corp (payroll software, higher tax prep fees, dedicated bank accounts) often outweigh the tax savings.
Are there extra hidden costs to running an S-Corp?
Yes. Running an S-Corp means you must run formal payroll (which costs around $40-$100/mo using tools like Gusto or QuickBooks Payroll), and your annual tax return becomes more complex (Form 1120-S), which means higher CPA fees.