S Corporation

An S Corporation isn't an entity type. It's an election you make with the IRS by filing Form 2553, and you can layer it on top of either an LLC or a corporation. The mechanics are what matter. Without the election, every dollar of net profit gets hit with self-employment tax at 15.3% (12.4% Social Security up to the $184,500 wage base in 2026, plus 2.9% Medicare with no cap). Elect S-Corp status and you split your income two ways: a reasonable W-2 salary that runs through payroll, and distributions that skip self-employment tax entirely.

Here's the math that makes people do it. Say you net $200,000. Pay yourself an $80,000 salary, take the remaining $120,000 as a distribution, and that $120,000 never sees the 15.3% — roughly $18,360 that stays in your pocket. The salary still carries full payroll tax, so the savings come from the distribution side, not the whole number.

The election isn't free. You're now running real payroll, filing a separate return (Form 1120-S) plus K-1s, and observing corporate formalities. Those costs typically eat the savings until net income clears the $60,000-$80,000 range. Below that, the prep fees and payroll admin can outweigh whatever you save on SE tax. Run the numbers before you elect — don't elect because someone at a conference told you to.

One change raised the stakes in 2026. OBBBA, signed in July 2025, made the Section 199A qualified business income deduction permanent, with the taxable-income thresholds where the wage and property limits phase in running $201,750-$276,750 for single filers and $403,500-$553,500 for joint filers in 2026. That 20% deduction gives S-Corp owners a fresh reason to keep salary low and distributions high — and the IRS knows it. Reasonable-compensation audits sit near the top of their enforcement list this year. Worth noting: your W-2 salary doesn't count as QBI, so shrinking the salary to chase the deduction can backfire.

That brings us to the trap. "Reasonable" salary is what you'd pay someone else to do your job — judged on your role, hours, experience, and market comps, not on a tidy 60/40 split. There's no IRS-blessed ratio and no safe harbor. Set your salary too low and the IRS can reclassify distributions as wages, then bill you for back payroll taxes, penalties, and interest going back to the original due dates. Document how you landed on the number, and revisit it as the business grows.