Choosing between a limited‑liability company (LLC) taxed as a sole proprietorship and an S corporation is a common crossroads for small‑business owners. While many focus solely on the potential reduction in self‑employment tax, a recent report from 1‑800Accountant adds the often‑overlooked expenses of operating an S corporation.

How the comparison was built

The study examined proprietary data from 6,908 small‑business clients in tax year 2025, separating them into two groups: Schedule C filers (LLCs or sole proprietors) and S‑corp filers. Revenue ranges were used to estimate median net income, then federal tax liability was calculated for 2026 using that year’s tax brackets, the standard deduction and the 20 % qualified business‑income deduction.

Because an S corporation must pay a “reasonable” salary before taking distributions, the analysis applied a common practitioner convention – 40 % salary and 60 % distribution for profitable S corps – to estimate payroll taxes. The remaining 60 % of earnings are treated as distributions, which are not subject to payroll tax.

Federal tax differences

Across every profitable revenue bracket, the S‑corp scenario showed a lower combined federal tax bill than the LLC scenario. The gap was small at lower profit levels – for example, at $22,543 of net income the estimated difference was $1,498 – and grew as net income rose above roughly $100,000.

However, the report warns that the federal‑tax advantage can be erased once the recurring costs of maintaining an S corporation are considered.

Recurring costs of an S corporation

• Second tax return: An S corporation files Form 1120‑S and issues Schedule K‑1 to shareholders. Preparation fees often exceed $1,000, compared with about $500 for a Schedule C return.
• Payroll administration: Running payroll for a reasonable salary requires quarterly Form 941 filings, W‑2 issuance and payroll‑service fees. Small‑business payroll services range from $20 to $200 per month plus per‑employee charges, translating to roughly $500‑$1,000 annually for a single owner‑employee.
• Compliance risk: The IRS evaluates reasonable compensation based on training, duties, time devoted and comparable industry pay. Misclassifying distributions as wages can trigger back payroll taxes, penalties and interest.
• State‑level taxes: Some states levy entity‑level taxes on S corporations. California, for example, requires the greater of $800 or 1.5 % of net income each year, even in a loss year. A default LLC taxed as a sole proprietor in California still owes the $800 minimum franchise tax but avoids the additional 1.5 % charge.

Formation costs are similar

Initial filing fees for creating either an LLC or a corporation are comparable, averaging about $130 and ranging from $35 to $500 depending on the state. The key cost differences arise from the recurring obligations listed above.

When the S‑corp election makes sense

Only about 21 % of S‑corp clients with revenue under $50,000 were profitable, and the estimated salary in that range ($3,800) is low enough to attract IRS scrutiny. For businesses consistently generating profits above $100,000, the federal tax savings may outweigh the additional expenses.

Owners should also review their specific state’s S‑corp filing requirements, as rules and fees vary widely. In states without entity‑level taxes, the cost gap narrows, but payroll and second‑return fees remain.

Bottom line for small‑business owners

The data suggests that an S corporation can provide a modest federal tax advantage once a business is reliably profitable and can support a reasonable salary. Until then, the added costs of a second tax return, payroll processing and potential state taxes often cancel out the benefit. Business owners are encouraged to consult a qualified tax professional to model their individual situation before making the election.

Original reporting: KEYT (Ventura/Santa Barbara) — read the source article.