November 3, 2025
Self-employed people often set up legal structures to protect themselves from personal liability stemming from their businesses. The primary legal structures that provide liability protection are Limited Liability Corporations (LLCs) and S-Corporations (S-Corps). Several factors are used to determine which structure is most advantageous, but tax considerations are a major factor.
S-Corps are generally more complex to operate than single-owner LLCs (aka single-member LLCs) with respect to business formation, operational complexity, and legal and tax compliance. However, a major factor in favor of S-Corps is their potential to reduce self-employment (FICA) taxes.
Single owners of sole proprietorships and LLCs must pay Self-Employment Tax (currently 15.3% for Social Security and Medicare) on 100% of their net business profits. An S-Corp owner who is also an employee must pay themselves a "reasonable compensation" salary (subject to the 15.3% FICA payroll tax). Any remaining net profit can be taken as an owner's distribution or dividend. Unlike the salary reported on a Form W-2, distributions from an S-Corp (reported on Form K-1) are still subject to Income Tax, but not FICA taxes.
The following is an example:
If your business profit is $100,000, and your reasonable salary is determined to be $$60,000, only the $$60,000 salary is subject to the 15.3% payroll tax. The remaining $40,000 distribution avoids that tax, resulting in substantial savings.
The IRS watches for owners who pay themselves an unreasonably low salary to maximize tax-free distributions. To justify the amount of payroll tax, the business owner should create a trail of evidence to support that his/her salary is "reasonable" and that the rest is a non-wage distribution of profit.
Given the complexity and the risk of IRS scrutiny, consulting a financial planner, CPA or tax professional experienced with S-Corporations is highly recommended to finalize a reasonable compensation plan.
For further reading, see:
https://www.legalzoom.com/articles/s-corp-vs-llc#:~:text=Owners%20receive%20additional%20profits%20as,portion%20of%20the%20owner's%20income.
https://www.wolterskluwer.com/en/expert-insights/s-corporation-advantages-and-disadvantages#:~:text=Operating%20as%20an%20S%20corporation,formal%20commitment%20to%20their%20business.
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