LLC vs. S Corporation Election: The Basics

"Should I form an LLC or an S corp?" is one of the most common formation questions — and it's built on a misunderstanding. You cannot form an S corporation at the Secretary of State, because an S corporation is not a state-law entity type. It's a federal tax status, named after Subchapter S of the Internal Revenue Code, that an eligible LLC or corporation can elect with the IRS.

The two separate decisions

Decision one — state law: you form either an LLC or a corporation with your state. This determines your filing fees, annual reports, governance rules, and liability structure. The costs differ by state and entity — compare them on the state comparison tool or any state page, like Delaware LLC costs.

Decision two — federal tax classification: you either keep the default (an LLC defaults to disregarded-entity or partnership treatment; a corporation defaults to C corporation treatment) or you file an election. Form 2553 makes an eligible entity an S corporation for tax purposes. The election is generally due within 2 months and 15 days of the start of the tax year it's meant to cover, though late-election relief exists.

What the S election actually does

An S corporation passes profits through to owners' personal returns (like a default LLC), but with one structural difference that drives nearly all of the interest in it: owner-employees must be paid a reasonable W-2 salary, and only that salary is subject to Social Security and Medicare payroll taxes. Remaining profit distributed to the owner is not subject to self-employment tax.

For a sole owner whose LLC nets, say, $120,000: as a default LLC, roughly all of it is subject to ~15.3% self-employment tax (with caps and deductions complicating the exact math). With an S election and a defensible $70,000 salary, the remaining ~$50,000 of distributions escapes payroll tax — a potential savings in the range of several thousand dollars a year, before subtracting the new costs the election creates.

The costs people forget

The election isn't free money. It typically adds payroll processing (~$500–$1,500/yr), a separate S corporation tax return (Form 1120-S, often $500–$1,500 in prep fees), state-specific S corp treatment that isn't always favorable (California, for instance, taxes S corporations 1.5% of net income with an $800 minimum), and IRS scrutiny of whether your salary is "reasonable." Below roughly $40,000–$60,000 of consistent annual profit, the overhead frequently eats the savings — one reason blanket "always elect S status" advice is unreliable.

Timing and undoing it

The election isn't a one-way door, but it's sticky. You can revoke S status, yet the IRS generally won't let you re-elect for five years afterward, so flip-flopping to chase each year's numbers doesn't work. Many owners run their first profitable year as a default LLC, look at the actual profit with their CPA, and file Form 2553 effective for the next tax year once the math clearly favors it — a calmer sequence than electing on day one based on projections.

Eligibility limits

S corporations can have at most 100 shareholders, all generally U.S. citizens or residents, one class of stock, and no entity shareholders (with narrow exceptions). Venture-funded startups almost never elect S status for exactly these reasons.

The takeaway

Form the entity your state situation calls for; treat the S election as a separate, revisitable tax decision once profits are consistent. The numbers above are illustrative, not predictions — whether the election helps you depends on your profit level, state, and payroll facts, which is squarely a question for a CPA or tax professional.