LLC vs. S-Corp for Contractors:
Sole Proprietor, LLC, and S-Corp Compared
A sole proprietor and a single-member LLC are taxed the same by default — both pay the full 15.3% self-employment tax on net profit. An LLC adds legal liability protection, not tax savings. The S-corp election is the step that can actually cut self-employment tax once your profit is high enough. Here is the full comparison.
Sole proprietor vs LLC vs S-corp, in one table
These are not three different ways to be taxed — they are two. A sole proprietor and a single-member LLC are taxed identically by default: net profit on Schedule C, the full 15.3% self-employment tax. The LLC just adds legal liability protection. The real tax fork is the S-corp election, which lets you take part of your profit as distributions that are not subject to self-employment tax — but only once your profit is high enough to justify the cost.
Sole proprietor: the default, and the simplest
If you start taking contracting work and never file anything to form a business, you are a sole proprietor. It is automatic — there is no paperwork, no state filing, and no separate tax return. You report your income and expenses on Schedule C with your personal Form 1040, and you pay self-employment tax on the net profit.
The simplicity is the appeal, and for a brand-new or side-income contractor it is often the right starting point. The catch is the part most contractors do not think about until something goes wrong: a sole proprietor has no liability protection. There is no legal line between you and the business, so a lawsuit or business debt can reach your personal assets — your truck, your savings, your home.
The LLC: liability protection, not a tax cut
This is the single most common misconception we correct for contractors, so read it twice: a single-member LLC, by default, does not save you a dollar in tax. The IRS treats it as a "disregarded entity," which means it is taxed exactly like a sole proprietor — same Schedule C, same full 15.3% self-employment tax on your net profit.
What an LLC actually buys you is legal liability protection. It creates a legal separation between you and the business, so (when maintained properly) a claim against the business generally cannot reach your personal assets. That protection is real and valuable — it is just a legal benefit, not a tax one.
So forming an LLC is a good move for the right reasons. But if someone sold you on it as a tax-saving move, that part was wrong until you take the next step: electing S-corp status.
The S-corp election: what it is and how it saves tax
An S-corp is not a different kind of business — it is a tax election you place on top of an existing LLC (or corporation) by filing IRS Form 2553. You keep your LLC; you just change how the IRS taxes its profit.
Here is the mechanic that creates the savings. As an S-corp owner you split your profit into two buckets: a reasonable salary paid to you as W-2 wages, and the remaining profit taken as distributions. The salary is subject to payroll tax (the same 15.3% in employer and employee Social Security and Medicare). But the distributions are not subject to self-employment or payroll tax. That untaxed slice is where the savings come from.
For how the 15.3% self-employment tax itself is built and calculated, see our self-employment tax guide.
The catch: you must pay yourself a "reasonable" salary first
No — and this is where do-it-yourself S-corps get into trouble. The IRS requires an S-corp owner who works in the business to pay themselves reasonable compensation as W-2 wages before taking distributions. "Reasonable" means roughly what you would have to pay someone else to do your job.
This is one of the most heavily scrutinized areas in small-business tax. Owners who pay themselves an artificially low salary to dodge payroll tax can have those distributions reclassified as wages, with back payroll tax, interest, and penalties. The salary number is not a knob you get to set to zero; it has to be defensible.
Getting reasonable compensation right is exactly the kind of judgment call that decides whether an S-corp election helps you or invites an audit — and it is a big reason this is a decision to make with a professional, not a calculator.
When moving up to an S-corp is actually worth it
The S-corp election only pays off once the self-employment tax it saves is bigger than the cost of running it. As a rule of thumb, that breakeven tends to land somewhere around $45,000 to $75,000 of net self-employment profit. Below that range, the payroll service, the extra business return, and the compliance overhead usually eat any savings.
But that range is genuinely a rule of thumb, not a promise. The exact breakeven depends on your reasonable salary, your state, and what it costs you to run payroll — which is why it requires an actual look at your numbers rather than a blanket threshold.
| Added cost or obligation | Why it exists |
|---|---|
| Payroll service | You must run real W-2 payroll for your salary |
| Separate business return (Form 1120-S) | The S-corp files its own return on top of your 1040 |
| Reasonable-compensation analysis | Your salary must be documented and defensible |
| State franchise tax or fees | Many states charge S-corps or LLCs annual fees |
| More bookkeeping | Cleaner books are required to separate salary from distributions |
How to decide: is the S-corp election right for you?
If you have read this far, you understand the ladder: sole proprietor is the simple default, an LLC adds liability protection, and the S-corp election is the move that can cut self-employment tax once your profit clears the breakeven. The comparison is the easy part. The decision — whether to elect, what salary to set, and when to file Form 2553 — is the part that needs your actual numbers.
That is a separate, deeper question with its own page. When you are ready to run your numbers and decide, go to our decision guide.
Frequently Asked Questions
Sole prop, LLC, or S-corp — which one actually fits you?
We work only with contractors. Book a free 30-minute call and we will look at your real numbers and tell you whether an S-corp election would save you money or just add overhead.
