An S Corp election generally saves business owners 15.3% in self-employment taxes on profits distributed to them, rather than paid as salary, often resulting in over $5,000–$8,000 in annual savings for high-earning businesses. The savings depend on paying a "reasonable salary" while taking the rest as a tax-exempt distribution.
S-Corp election lets you split your profits into “shareholder wages” (subject to 15.3% self-employment taxes) and “distributive share” (NOT subject to 15.3% self-employment taxes). Active owners in an S-Corp must pay themselves a reasonable salary, but realize a 15.3% savings on the rest of their retained profits.
The "2% rule" for S Corporations treats shareholders owning more than 2% of the company's stock (or voting power) differently for fringe benefits, classifying them like partners in a partnership, not regular employees; this means benefits like health insurance premiums paid by the S Corp must be included as taxable wages on their W-2, rather than being tax-free, though the shareholder can often deduct these premiums as an "above-the-line" deduction. This rule prevents them from participating in tax-advantaged Section 125 cafeteria plans, making benefits like Health FSAs unavailable on a pre-tax basis.
S corp advantages over a C corp
S corps offer advantages to small business owners because they provide tax benefits and the same limited liability protection as a corporation. Not all businesses qualify for S corporation status.
The 60/40 rule is a simple approach that helps S corporation owners determine a reasonable salary for themselves. Using this formula, they divide their business income into two parts, with 60% designated as salary and 40% paid as shareholder distributions.
Health Reimbursement Arrangements (HRAs): HRAs allow companies to reimburse employees for certain medical expenses, including wellness-related costs like gym memberships, in some cases. However, for S-Corp owners, reimbursement of personal health costs may be considered taxable income.
As a pass-through entity, one of the biggest tax advantages of the S corp business structure is that it avoids double-taxation, which means S corps don't have to pay taxes at the federal level the way C corps do. Instead, S corp profits are only taxed once, on the personal tax returns of individual shareholders.
However, while purchasing real property through an S-Corp is legal, there are serious tax implications at play. If your S-Corp owns a residential property and the property is subsequently distributed to a shareholder, including yourself, any financial gains on the property become taxable at an unattractive rate.
Ordinary and necessary business expenses are deductible if they are directly related to operating your S corporation. Common examples include: Office supplies and software (e.g., Microsoft 365, Adobe Creative Cloud). Marketing expenses and advertising (website hosting, digital ads, business cards).
Your S corporation can have a net loss for the year and do something that causes a salary. And if the IRS and/or the courts find that your S corporation did not pay you reasonable compensation, you can experience a new surprise salary, payroll taxes, and penalties. This will make your bad year worse.
As a result, you can pay yourself once annually. However, note that there may be an obligation to file Form 941 reports (whether you have taxes to report or not) on a quarterly basis, so you should take that into consideration.
S-Corp reasonable salary is the market-rate compensation you must pay yourself before taking distributions, typically ranging from $40,000-$150,000+, depending on your role, industry, and location. The IRS requires this to prevent payroll tax avoidance, with penalties reaching 20% plus interest for non-compliance.
An S corporation must file its annual tax return by the 15th day of the third month after the tax year ends. This is usually March 15 unless that day is a weekend or holiday. The business must report all financial activity on Form 1120S.
The 70/20/10 rule for money is a simple budgeting guideline that splits your after-tax income into three categories: 70% for Needs (essentials like rent, groceries, bills), 20% for Savings & Investments (emergency funds, retirement), and 10% for Debt Repayment & Donations (extra debt payments or giving). It balances immediate living costs with long-term financial security, helping you cover necessities while building wealth and paying off liabilities.
The most tax-efficient way for many active LLC owners is to elect S-corporation status, paying yourself a "reasonable" W-2 salary subject to payroll taxes, with remaining profits taken as distributions (dividends) not subject to self-employment tax, saving ~15% on the distribution portion. For single-member LLCs or those with lower profits, owner's draws (flexible withdrawals) are simpler but all profits are subject to self-employment tax, while a salary-only approach (default LLC/sole prop) also taxes all net income at full self-employment rates. Always consult a tax professional, as the best method depends on your specific income and business structure.