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What are the Benefits of Changing Your Sole Proprietor or LLC Business to an S Corporation?

Running a business as a sole proprietor (filing Schedule C) can be simple to start—but as your profits grow, the tax and liability disadvantages can pile up. Transitioning to an S Corporation (S Corp) can unlock strategic advantages. Here are the top 10 reasons business owners make this change.

1. Self-Employment Tax Savings

The biggest draw of an S Corp is the ability to split income between salary and distributions. You only pay FICA taxes (Social Security and Medicare) on your salary—not on distributions—potentially saving thousands each year.

2. Audit Risk Reduction

Schedule C filers face a higher audit risk (up to 4x more) than S Corps. By switching to an S Corp and filing a corporate tax return (Form 1120-S), the business appears more structured and compliant, decreasing the likelihood of an IRS audit.

3. Legitimacy and Business Credibility

Operating as an S Corp projects professionalism. Vendors, lenders, and clients often view incorporated businesses as more established and trustworthy.

4. Limited Liability Protection

Like LLCs, S Corps provide personal asset protection. Creditors generally cannot pursue your personal property to satisfy business debts (if corporate formalities are followed).

5. Health Insurance Tax Deduction

As an S Corp owner-employee, you may deduct health insurance premiums paid through the corporation, as long as you meet eligibility and reporting criteria.

6. Retirement Contribution Opportunities

S Corps allow owners to maximize retirement savings through solo 401(k)s and SEP IRAs. W-2 wages enable larger contributions compared to self-employed income alone.

7. Business Expense Deductions

S Corps can offer broader deduction opportunities, such as vehicle reimbursements, accountable plans, and home office reimbursements—if handled correctly under IRS rules.

8. Income Splitting for Spouses

S Corp structures allow income splitting with family members, especially spouses who perform services. This can optimize household tax brackets and benefits.

9. Better Succession Planning

S Corporations have clearer structures for transferring ownership or bringing in new shareholders, making succession or sale easier than with a sole proprietorship.

10. Avoidance of Double Taxation (Unlike C Corps)

S Corps offer pass-through taxation, meaning profits are only taxed once at the shareholder level—avoiding corporate-level taxes imposed on C Corporations.

Example: 3-Year Tax Comparison: Schedule C vs S Corporation (with 24% Income Tax Rate)

Assumptions:

Parameter

Value

Starting Net Income (Year 1)

$100,000

Annual Growth Rate

20%

S Corp Salary

60% of net income

S Corp Distribution

40% of net income

SE / Payroll Tax Rate

15.3%

Federal Income Tax Rate

24%

State Tax:

Ignored for simplicity

Payroll/Admin Costs

Ignored (net benefit focus)

Year-by-Year Comparison Year 1 – Income: $100,000

Schedule C

S Corp

Salary

N/A

$60,000

Distribution

N/A

$40,000

SE/Payroll Tax

$15,300

$9,180

Income Tax

$24,000 (24% of $100k)

$24,000

Total Tax

$39,300

$33,180

Tax Savings

$6,12

 

  Year 2 – Income: $120,000

Schedule C

S Corp

Salary

N/A

$72,000

Distribution

N/A

$48,000

SE/Payroll Tax

$18,360

$11,016

Income Tax

$28,800

$28,800

Total Tax

$47,160

$39,816

Tax Savings

$7,344

Year 3 – Income: $144,000

Schedule C

S Corp

Salary

N/A

$86,400

Distribution

N/A

$57,600

SE/Payroll Tax

$22,032

$13,219

Income Tax

$34,560

$34,560

Total Tax

$56,592

$47,779

Tax Savings

$8,813

Total 3-Year Summary

Schedule C

S Corp

Total SE/Payroll Tax

$55,692

$33,415

Total Income Tax

$87,360

$87,360

Total Tax Paid

$143,052

$120,775

💵 Total Tax Savings

$22,277

Why This Matters

Even with the same income tax under both structures:

  • The S Corp saves you from paying SE tax on distributions.

  • Over 3 years, this results in over $22,000 in net tax savings—a powerful reason to consider restructuring.

Key Takeaways

  1. S Corps don’t eliminate income tax, but they significantly reduce self-employment tax by splitting income between salary and distributions.

  2. As your profits grow, the tax savings compound.

  3. These savings can easily offset additional costs of payroll and corporate tax filing when profits exceed ~$50K.

Before switching, consult with a CPA or tax advisor to ensure eligibility and to properly structure your compensation and filings.  Don Thomas CPA firm is available for a free consultation by clicking on www.donthomascpa.com.

 

 

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