The S-Corp “Savings”? What the Payroll-Tax Pitch Leaves Out
Updated: 2 days ago
Every few weeks a client tells me some version of the same thing: "My accountant friend says I should be an S-corp. It saves self-employment tax." It can. It can also save a lot less than the headline suggests, and sometimes it costs you money. The honest answer needs the whole picture, so here is one example run all the way through.
Meet Maria
Maria* is single, lives in California, and runs an e-commerce business through a single-member LLC. She earns $150,000 of profit a year. Her sole proprietor math looks like this: self-employment tax of about $21,081.
If she elects S-corp status and pays herself a $90,000 salary, payroll tax on that salary is about $13,770. The gap is $7,311 a year. That is the number in every S-corp pitch.
It is not what she keeps.
Where the $7,311 goes
1. A smaller QBI deduction (about $3,616 more income tax)
Sole proprietors can deduct up to 20% of qualified business income under §199A. W-2 salary you pay yourself is not qualified business income. Moving $90,000 of profit into salary shrinks Maria's QBI deduction from about $24,512 to about $9,963, which raises her federal income tax by roughly $3,616.
2. Admin cost (about $2,500)
An S-corp needs payroll processing, a separate Form 1120-S, and usually a higher bookkeeping and preparation fee. I use $2,500 here. Your number will vary, but it is never zero.
3. California (about $0 extra, in this case)
California taxes an S-corp at the greater of 1.5% of net income or $800. This example assumes Maria already has a single-member LLC, which pays the $800 LLC tax anyway; an LLC taxed as an S-corp does not pay it twice. At her income the 1.5% works out to less than $800, so the minimum applies and nothing extra is added (see the box below if you have no LLC). California personal income tax is roughly a wash either way. At higher incomes the 1.5% and the LLC fee tiers start to matter, so check yours.
The bridge: $7,311 − $3,616 − $2,500 − $0 = $1,195 a year. Real, but about one-sixth of the headline.
No LLC today? The $0 above assumes Maria already pays California's $800 LLC tax. A sole proprietor with no LLC pays no California entity tax at all, so the S-corp's $800 minimum is a brand-new cost. Her real saving drops to about $639 (less than $800 because that $800 is also deductible on the S-corp side), and break-even moves from about $80,000 of profit to roughly $110,000–$125,000.
The salary dial
The salary you choose is the biggest lever. Lower salary means more savings on paper, but the IRS expects "reasonable compensation" for the work you actually do. Here is Maria's net result at different salaries, on the same $150,000 of profit.
At a $50,000 salary the benefit looks like $8,159. At $110,000 she is actually $2,531 worse off than staying a sole proprietor. The 60% salary I used is illustrative, not a rule. The right number depends on your role, your industry, and what you would pay someone else to do the work.
The Watson case. A CPA firm owner paid himself $24,000 while taking more than $175,000 in distributions. The 8th Circuit upheld the IRS's finding that about $91,044 was reasonable compensation, and the unpaid payroll tax came with it. Low-balling salary is the single most common way this strategy fails.
When does it start to pay?
At low profit, the fixed costs eat the savings. Using the same assumptions, with salary scaled to profit:
With an LLC, the election loses about $697 a year at $60,000 of profit, turns positive around $80,000, and keeps growing from there. Without an LLC, the extra $800 of California tax pushes break-even out to roughly $110,000–$125,000 of profit. At $150,000 the gain is about $639 instead of $1,195.
Where the S-corp does better than this example
Higher income. Once you are past the QBI income thresholds (about $201,775 single for 2026), the deduction is limited by W-2 wages paid. Salary you pay yourself then helps rather than hurts, and the S-corp can come out ahead.
The California pass-through entity tax. The elective PTET lets the entity pay California tax at up to 9.3% of qualified net income and deduct it federally, which works around the $40,400 SALT cap for 2026. Partnerships and S-corps can use it. A disregarded single-member LLC or plain sole proprietor cannot. SB 132 extended it through 2030 and removed the June 15 prepayment requirement starting in 2026.
Retirement and benefits planning. A salary can support some plan contributions and health insurance strategies, though a sole proprietor has good options too.
Where it does worse
Profit under roughly $80,000, as the numbers above show.
Service businesses (SSTBs) above the income thresholds, where QBI phases out regardless.
Owners who need loan or mortgage underwriting based on self-employment income, since salary-plus-K-1 can look lower to lenders.
Timing: Form 2553
To be an S-corp for a given year, file Form 2553 within 2 months and 15 days of the start of that year. For a January 1, 2027 effective date, the deadline is March 15, 2027. Missed it? Rev. Proc. 2013-30 offers late-election relief if you meet its conditions. Then set up payroll before you take your first paycheck.
The bottom line
The S-corp election is a good tool at the right profit level with a defensible salary. It is not free money. Before you elect, run the whole bridge — payroll tax, QBI, admin, California — with your own numbers, and revisit it each year as profit changes.
*Illustration assumptions: single filer, 2026 federal rates, California single-member LLC, non-SSTB business, standard deduction, $2,500 admin cost, taxable income below the QBI threshold. Figures assume an existing single-member LLC; without one, results are lower as shown in the "No LLC today?" box. This is general information, not tax advice for your situation.
