Business structure
Sole proprietorship vs S corp: which costs less in tax?
A sole proprietor pays 15.3% self-employment tax on all of the business’s profit. An S corporation owner pays Social Security and Medicare only on the salary the company pays them, and takes the rest as distributions without those taxes. That difference is the whole case for an S corp, and it only pays off once profit is high enough to cover a fair salary, payroll and a second tax return.
Sole proprietorship vs S corp at a glance
An S corporation is a tax election, not a different kind of business: a corporation or an LLC can make it, and a sole proprietor first has to form one.
| Item | Sole proprietorship | S corporation |
|---|---|---|
| How you are paid | You keep the profit; no salary | A reasonable W-2 salary, then distributions |
| Social Security and Medicare | 15.3% self-employment tax on 92.35% of all profit | 15.3% payroll tax on your salary only, half paid by the company |
| Federal return | Schedule C with your Form 1040, due April 15 | Form 1120-S and Schedule K-1, due March 15, plus your Form 1040 |
| Payroll | None for you | Required for your salary: withholding, Forms 941, W-2 |
| QBI deduction | On the business profit | On the profit after your salary; the salary does not qualify |
| Illinois replacement tax | None | 1.5% of net income |
| Who can own it | One individual | Up to 100 shareholders, no nonresident aliens, partnerships or corporations |
How a sole proprietorship is taxed
A sole proprietorship, or a single-member LLC that has not elected otherwise, reports its profit on Schedule C. You pay income tax on the profit at your normal rates and self-employment tax of 15.3% on 92.35% of it, with the Social Security part stopping at $184,500 of combined earnings for 2026. There is no separate business return and no payroll for yourself.
How an S corporation is taxed
An S corporation is a corporation, or an LLC, that has elected S status on Form 2553. It pays no federal income tax itself: its profit passes through to the owners on Schedule K-1. The IRS requires it to pay a shareholder who works in the business reasonable compensation before making non-wage distributions, and that salary carries Social Security and Medicare tax through payroll like any employee’s.
The saving is on the profit above the salary. Set the salary too low and the IRS can reclassify distributions as wages, with back payroll taxes and penalties.
Health insurance for S corp owners
For an owner of more than 2% of an S corporation, health insurance the company pays is included in W-2 wages in box 1 but not in the Social Security and Medicare boxes when it is paid under a plan for employees. The owner can then take the self-employed health insurance deduction on their own return. A sole proprietor takes the same deduction directly.
When an S corp makes sense
An S election usually pays off when all three are true:
- Profit is steady and well above what a reasonable salary for your work would be.
- You can run payroll every pay period and file Form 1120-S by March 15.
- The payroll-tax saving beats the added costs: payroll service, the business return and, in Illinois, the 1.5% replacement tax.
Is it time for an S election?
We run the numbers on your actual profit, form the LLC or corporation if you need one, starting at $250 plus the state fee, file Form 2553 and prepare the Form 1120-S each year.
Questions people ask
Is an S corp a sole proprietorship?
No. A sole proprietorship is you doing business on your own, reported on Schedule C. An S corporation is a corporation or LLC that has elected S status, files its own Form 1120-S and pays you a salary.
Do S corps pay less tax than a sole proprietorship?
Often, once profit is high enough. The S corp owner avoids Social Security and Medicare tax on profit above a reasonable salary, but pays for payroll, a separate return and, in Illinois, a 1.5% replacement tax.
Can a sole proprietor become an S corp?
Not directly. You first form a corporation or an LLC, then file Form 2553 to elect S status, within 2 months and 15 days of the start of the tax year it should apply to.
What is a reasonable salary for an S corp owner?
What the business would pay someone else to do your work. The IRS requires it before distributions and looks at your duties, time and what comparable businesses pay.
Where these rules come from
- IRS: S corporations
- IRS: S corporation compensation and medical insurance issues
- IRS: Instructions for Form 1120-S
- IRS: Self-employment tax (Social Security and Medicare taxes)
- IRS: Instructions for Form 2553
- Illinois Department of Revenue: tax rates
General information, current when written, not advice about your situation. Fees and forms change; the official pages above are the authority.
