Tax Guide

S Corp vs. Sole Prop: where the savings come from

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As a sole proprietor, all of your net business profit is subject to self-employment tax (Social Security + Medicare, currently 15.3% up to the Social Security wage base, 2.9%+ above it). As an S Corp, only your W-2 salary is subject to payroll tax — distributions above that salary are not.

Illustrative example

Say your business nets $120,000 in profit for the year. Here's roughly how the two structures compare (illustrative only — not a substitute for an actual calculation on your numbers):

  • Sole Proprietor: self-employment tax applies to essentially the full $120,000 of profit.
  • S Corp: you might pay yourself a reasonable salary of, say, $65,000 (subject to payroll tax) and take the remaining $55,000 as a distribution (not subject to self-employment tax).

The gap between "profit taxed at self-employment rates" and "profit taken as a distribution" is roughly where the savings come from — offset by the added cost of running payroll and filing a separate business return.

What "reasonable salary" means

The IRS doesn't let you set your salary to $1 and take everything else as a distribution. Your salary needs to reflect what someone else would reasonably be paid to do your job. This is the single most scrutinized number in an S Corp return, and it's not a DIY guess — it should be benchmarked against your role, industry, and hours.

Where the break-even usually sits

Below a certain profit level, the added cost of payroll processing, unemployment insurance, and a separate corporate return can outweigh the self-employment tax savings. Above that level, the savings tend to outpace the added costs. Run your own numbers below.

Run The Numbers

S Corp Tax Savings Calculator

Model the real advantage of an S corp election — including all overhead costs, payroll taxes, lost QBI, basis risk, and SSTB impacts.

Business Profile
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Your Schedule C net income, or projected S corp net profit before salary
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Stacks on top of business income — affects bracket and §199A phase-out
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Enter 0 for TX, FL, WA, NV, SD, WY, AK. Approximation — actual liability varies
Business Type & SSTB Status
Annual S Corp Overhead Costs
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Extra cost above sole prop. S corps require Form 1120-S, quarterly payroll deposits, W-2s, and more complex books. Typical range: $2,000–$6,000/yr.
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Gusto, Rippling, ADP, etc. to handle owner payroll, tax deposits, and W-2 filing. Typical range: $500–$1,800/yr.
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Most states charge annual fees to keep corporate status active — from $25 to $800+. Includes registered agent (~$100–$300/yr). CA adds an $800 minimum franchise tax.
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Annual meeting documentation, corporate resolutions, separate business banking, shareholder agreement updates, etc.
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Total Annual S Corp Overhead: $0 This is the fixed cost hurdle your FICA savings must beat to make the S corp worthwhile.
Owner Salary & Employment Taxes
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IRS requires a "reasonable salary" for services performed. Too low = audit risk and potential recharacterization + penalties. Common safe range: 40–60% of net profit for service businesses. Document your methodology.
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Your state's employer unemployment tax rate. New employer rates typically range from 1%–4%. Check your state's labor department for your rate.
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Maximum wages subject to SUTA per employee. Ranges from $7,000 (CA, AZ) to $68,500 (WA). Look up your specific state.
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W-2 wages paid to employees other than the owner. These count toward the §199A W-2 wage limitation test — higher total wages support a larger QBI deduction once income enters the phase-out range. Does not include owner salary (entered above).
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Total W-2 for §199A = owner salary + this amount
Employer Payroll Tax Breakdown
Social Security (6.2%, up to SS wage base)—
Medicare (1.45%)—
FUTA (0.6% on first $7,000)—
SUTA (state unemployment)—
Total Employer Payroll Taxes—
Basis & Excess Distribution Analysis (Farming, Construction & Capital-Heavy Businesses)
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Why This Matters In an S corp, only loans you personally make to the corporation create debt basis. Entity-level bank loans (operating lines, equipment notes) do not flow through to increase your stock basis — unlike a partnership. If cumulative distributions exceed your stock + debt basis, the excess is taxed as capital gain (not ordinary income). For farmers with $400K equipment loans or contractors funded by customer deposits, this can be a significant issue.
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Initial investment + cumulative S corp income - cumulative losses - prior distributions. For a converted LLC or new S corp, this is often just your initial equity contribution.
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If you personally loaned money to your S corp (on a promissory note), that creates debt basis. Bank loans guaranteed by you but taken by the corp do NOT count.
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The original purchase cost of tangible depreciable property held by the S corp (equipment, machinery, buildings) — not reduced for depreciation. Used in the §199A alternative W-2 test: max(50% of W-2 wages, 25% of W-2 wages + 2.5% of UBIA). Critical for capital-heavy businesses like farming and construction with large equipment bases but relatively low W-2 wages.
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Original cost of equipment/property (not depreciated value) · Supports higher §199A deduction at incomes above the phase-out threshold
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Leave at 0 to auto-use the S corp's net income as the distribution. Enter a HIGHER amount to model capital-heavy scenarios — e.g., a farmer taking $200K out while the S corp only earned $80K (funded by an operating line of credit). The excess tests your basis.
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Enter 0 to auto-calculate · Enter a larger amount to model debt-funded distributions (farming operating loans, construction deposits, etc.)
Applies to any excess distribution above your basis (taxed as capital gain, not ordinary income — which can actually be a benefit if rates are lower)
Tax Comparison Results
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Sole Prop
Effective Tax Rate
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S Corp
Effective Tax Rate
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FICA/SE Tax
Savings (Gross)
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S Corp
Overhead Cost
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Approx. Break-Even
Net Profit
Line Item Sole Proprietor S Corporation Difference

For educational and planning purposes only — not tax advice. Consult a qualified CPA before making an S corp election.

Uses 2025 federal tax parameters (2026 figures are estimated). State taxes are simplified approximations.

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