LLC vs S-Corp for Freelancers: When to Switch and How Much You’ll Save
I operated as a sole proprietor for 2.5 years before my accountant said six words that changed my tax bill: “You should consider S-Corp election.” She ran the numbers. The estimated savings: $4,800/year in self-employment tax. The cost: about $1,500/year in additional payroll and tax filing expenses. Net savings: $3,300/year, every year, going forward.
I kicked myself for not doing it sooner. Then I realized — at my income in years 1-2, it actually wouldn’t have saved enough to justify the complexity. Timing matters. Here’s how to time it right.
The Quick Version
| Structure | Best For | Tax Treatment | SE Tax |
|---|---|---|---|
| Sole Proprietor | Starting out, income under $50K | Schedule C on personal return | 15.3% on all net income |
| Single-Member LLC | Liability protection, income under $80K | Same as sole prop (default) | 15.3% on all net income |
| LLC with S-Corp Election | Income consistently over $80K | Salary + distributions | 15.3% on salary only |
The key insight: An LLC doesn’t change your taxes. S-Corp election does. These are separate decisions, and most people confuse them.
Sole Proprietor: Where Most Freelancers Start
When you start freelancing without forming any business entity, you’re automatically a sole proprietor. No paperwork needed. You report business income on Schedule C of your personal tax return.
Pros:
- Zero setup cost or paperwork
- Simplest tax filing
- No ongoing maintenance requirements
Cons:
- No liability protection (your personal assets are at risk if someone sues your business)
- You pay 15.3% self-employment tax on ALL net income
- Some clients prefer working with LLCs/corporations
Stay as a sole proprietor if: You’re making under $50K, don’t have significant personal assets to protect, and want maximum simplicity.
LLC: Liability Protection Without Tax Changes
A single-member LLC creates a legal separation between you and your business. If a client sues your business, they can go after business assets but (generally) not your personal savings, car, or home.
The key misconception: An LLC does NOT change your taxes by default. A single-member LLC is a “disregarded entity” for federal tax purposes. You still file Schedule C. You still pay 15.3% SE tax on all net income. The IRS literally ignores the LLC.
What an LLC does:
- Protects personal assets from business liability ✅
- Makes you look more professional to clients ✅
- Required by some enterprise clients ✅
- Changes your tax bill ❌ (not by default)
LLC formation costs by state:
| State | Filing Fee | Annual Fee |
|---|---|---|
| Wyoming | $100 | $60 |
| Delaware | $90 | $300 |
| New Mexico | $50 | $0 |
| California | $70 | $800 (yes, really) |
| New York | $200 | $25 + publication (~$1,500) |
My experience: I formed an LLC in North Carolina ($125 filing, $200/year annual report) at month 18 when I started landing $5,000+ projects. The liability protection felt necessary once the stakes increased.
When to form an LLC:
- You’re signing contracts worth $5,000+
- You have personal assets worth protecting (home, savings, investments)
- A client or contract requires it
- You want the option to elect S-Corp later
S-Corp Election: The Tax Savings Move
Here’s where it gets interesting. You can elect to have your LLC taxed as an S-Corporation. This doesn’t change your LLC’s legal structure — it only changes how the IRS treats your income.
How S-Corp Saves Money
As a sole proprietor/LLC, you pay 15.3% self-employment tax on ALL net income.
As an S-Corp, you split your income into two buckets:
- Salary (W-2 wages you pay yourself) — Subject to FICA taxes (15.3%)
- Distributions (remaining profit) — NOT subject to FICA taxes
The distributions are the savings. Every dollar you take as a distribution instead of salary avoids 15.3% in payroll/SE taxes.
Real Numbers: My Situation
Net self-employment income: $100,000
Without S-Corp (sole proprietor):
- SE tax base: $100,000 × 0.9235 = $92,350
- SE tax: $92,350 × 0.153 = $14,130
- Total FICA/SE tax: $14,130
With S-Corp (salary $60,000, distribution $40,000):
- FICA on salary: $60,000 × 0.153 = $9,180 (split between employer/employee)
- FICA on distribution: $0
- Total FICA: $9,180
Annual savings: $14,130 - $9,180 = $4,950
That’s real money. Every year. And it increases as your income increases.
The “Reasonable Salary” Requirement
The IRS requires your S-Corp salary to be “reasonable” for your industry and experience. You can’t pay yourself $20,000 on $150,000 in revenue and take $130,000 as distributions. That’s too aggressive and will get flagged.
What’s “reasonable”?
- Research what similar roles pay as W-2 employees
- Most CPAs recommend 50-60% of net income as salary
- Consider industry norms, your experience level, and local cost of living
- Document your reasoning in case of audit
My salary: $60,000 on ~$100,000 net income. My CPA determined this based on comparable web developer salaries in my area. The remaining $40,000 comes as quarterly distributions.
S-Corp Costs
S-Corp isn’t free. You need to factor in:
| Cost | Annual Amount |
|---|---|
| Payroll service (Gusto, ADP) | $480-720/year ($40-60/month) |
| Additional tax filing (Form 1120S) | $500-1,500/year (CPA fee increase) |
| State S-Corp fees (varies) | $0-800/year |
| Worker’s comp insurance (some states) | $200-500/year |
| Total additional costs | $1,200-3,500/year |
The Break-Even Calculation
S-Corp saves you roughly 15.3% on your distribution amount, minus the additional costs.
At $60K net income:
- Potential savings: ~$2,300
- Additional costs: ~$1,500-2,500
- Net savings: $0-800 → Marginal. Probably not worth the hassle.
At $80K net income:
- Potential savings: ~$3,600
- Additional costs: ~$1,500-2,500
- Net savings: $1,100-2,100 → Starting to make sense.
At $100K net income:
- Potential savings: ~$4,950
- Additional costs: ~$1,500-2,500
- Net savings: $2,450-3,450 → Clearly worth it.
At $150K net income:
- Potential savings: ~$8,500
- Additional costs: ~$2,000-3,000
- Net savings: $5,500-6,500 → No-brainer.
The common wisdom: S-Corp makes sense around $80K net income. Below that, the savings don’t justify the complexity. Above that, you’re leaving money on the table.
How to Actually Do It
Step 1: Form an LLC (If You Haven’t)
File Articles of Organization with your state. Cost: $50-200.
Step 2: Get an EIN
Free from the IRS. Takes 5 minutes online at irs.gov.
Step 3: Elect S-Corp Status
File Form 2553 with the IRS. Must be filed by March 15 for the current tax year (or within 75 days of LLC formation). This is a one-time filing.
Step 4: Set Up Payroll
You need to pay yourself through proper payroll — with W-2s, withholding, and employer tax deposits. Services like Gusto ($40/month) or Wave Payroll ($20/month) handle this. You cannot just write yourself a check and call it salary.
Step 5: Pay Yourself
Run payroll regularly (biweekly or monthly). The remaining profit gets distributed quarterly (or as needed).
Step 6: File Properly
Your CPA files Form 1120S (S-Corp return) in addition to your personal return. The S-Corp return is due March 15 (before your personal return deadline of April 15).
Common S-Corp Mistakes
Mistake 1: Electing too early. At $50K income, the $1,500-2,500 in additional costs eats most of the savings. Wait until $80K+.
Mistake 2: Setting salary too low. The IRS scrutinizes unreasonably low S-Corp salaries. If comparable employees earn $70K and you’re paying yourself $30K, expect a letter.
Mistake 3: Not running proper payroll. You must withhold income tax, Social Security, and Medicare from your salary. You must make employer tax deposits. You must file quarterly payroll returns. This isn’t optional.
Mistake 4: Missing the election deadline. Form 2553 must be filed by March 15 for the current tax year. Miss it and you wait another year (though late election relief is sometimes available).
Mistake 5: DIYing the tax return. An S-Corp return (Form 1120S) is significantly more complex than a Schedule C. This is where a CPA earns their fee. Don’t try to do it yourself in TurboTax.
My Recommendation
Year 1-2 (income under $50K): Sole proprietor. Maximum simplicity.
Year 2-3 (income $50-80K): Form an LLC for liability protection. Continue filing as sole proprietor for taxes. The LLC doesn’t change your tax situation but protects your assets.
Year 3+ (income consistently over $80K): Elect S-Corp tax treatment for your LLC. Set up payroll. Hire a CPA if you haven’t already. Enjoy the tax savings.
This is roughly the path I followed, and it optimized for both simplicity (early) and savings (later). Don’t overcomplicate your business structure before your income justifies it.
The Bottom Line
LLC = liability protection (legal). S-Corp = tax savings (financial). They solve different problems. You can have one without the other, but most established freelancers eventually have both.
The S-Corp decision is pure math: savings minus costs. When the math clearly favors S-Corp ($80K+ net income for most freelancers), make the switch. When it doesn’t, keep it simple.
And please — talk to a CPA before making either decision. The $300-500 for a consultation is the best money you’ll spend. They’ll run your specific numbers, account for your state’s rules, and tell you exactly when to pull the trigger.