LLC vs. S-Corp for Contractors: Which One Saves You More Money?

One of the most common questions from contractors starting out — or contractors who've been running as a sole prop for a few years and are finally doing the paperwork — is whether to form an LLC or elect S-Corp status.

The short answer: it depends on how much you're making. But the longer answer is worth understanding, because the difference can mean thousands of dollars a year in taxes.

Note: This is general educational information, not tax advice. Talk to a CPA who works with small businesses before making any entity decisions.

Start With the Basics

Sole Proprietorship: No formal structure. You and the business are legally the same. Simple, but offers zero liability protection and you pay self-employment tax on every dollar of profit.

LLC (Limited Liability Company): A legal structure that separates you from the business. Creditors can go after the business, not your personal assets. By default, a single-member LLC is taxed exactly like a sole prop — all profit flows through to your personal return and gets hit with self-employment tax (15.3% on the first ~$160,000 of net earnings in 2024).

S-Corporation: A tax election, not a business structure. You still form an LLC (or corporation) first, then file Form 2553 with the IRS to be taxed as an S-Corp. The key benefit: you split your income between a 'reasonable salary' (subject to payroll taxes) and 'distributions' (not subject to self-employment tax).

Why S-Corp Status Saves Money — At the Right Income Level

Here's a simplified example. A plumbing contractor nets $120,000 after business expenses.

As an LLC (default): All $120,000 is subject to self-employment tax (~15.3%). SE tax bill: ~$18,360.

As an S-Corp: You pay yourself a reasonable salary of $70,000. The remaining $50,000 comes out as a distribution. Payroll taxes apply only to the $70,000 salary: ~$10,710. The distribution is not subject to SE tax. Estimated savings: ~$7,600/year.

That's not nothing. Over five years, that's $38,000.

But here's the catch: S-Corps come with real costs. You're required to run actual payroll (a payroll service costs $50–$150/month), file additional tax returns, and maintain more formal accounting. For most CPAs, the S-Corp election makes sense somewhere around $60,000–$80,000 in net profit. Below that, the savings don't outweigh the overhead.

The S-Corp 'Reasonable Salary' Problem

The IRS requires S-Corp owners to pay themselves a 'reasonable salary' for the work they actually do. If you pay yourself $20,000 and take $150,000 in distributions, the IRS will notice — and they will reclassify those distributions as wages and hit you with back payroll taxes plus penalties.

'Reasonable' is loosely defined, but think: what would you pay someone else to do your job? For a working plumber-owner, that's probably $50,000–$90,000 depending on your market. Don't try to game this. The tax savings are real, but they only work if you do it correctly.

Which Is Right for You?

Under $50K net profit: LLC (default taxation) — keep it simple.

$60K–$80K+ net profit: Talk to a CPA about S-Corp election.

Multiple owners or partners: LLC with an Operating Agreement at minimum.

Want maximum liability protection: Both structures work; LLC is simpler.

Growing fast and planning to add employees: S-Corp election likely worth it sooner.

One Thing Everyone Should Do Regardless of Entity

Open a separate business bank account immediately. Running business income and expenses through your personal account is the fastest way to lose your liability protection (called 'piercing the corporate veil') and makes your taxes a nightmare. Most banks offer free business checking — there's no reason not to do this on day one.

The Bottom Line

Form an LLC to protect your personal assets. Run it as a sole prop for tax purposes until your net profit consistently hits $60K+, then talk to a CPA about the S-Corp election. Don't pay for complicated structure you don't need yet — but don't leave money on the table once you've earned it.

The Small Business Startup Bundle includes an LLC vs. S-Corp comparison guide, a startup budget worksheet, and a 12-month cash flow forecast to help you get the financial foundation right from day one.

This post is for educational purposes only and does not constitute legal or tax advice. Consult a licensed CPA or attorney for guidance specific to your situation.