Operating as a standard single-member LLC means all net earnings are subject to the 15.3% Self-Employment Tax (Social Security and Medicare) via Schedule SE. By electing S-Corporation tax status (Form 2553), business owners can legally reduce this tax burden.
The S-Corp Advantage: Two Streams of Income
As an S-Corp shareholder-employee, your earnings split into two distinct channels:
- W-2 Salary: Subject to standard payroll withholdings and 15.3% FICA taxes.
- Shareholder K-1 Distributions: Flow-through profits that are exempt from the 15.3% self-employment tax.
Determining an IRS-Defensible "Reasonable Salary"
The IRS strictly audits S-Corps that pay artificially low salaries (such as $10,000 salary with $150,000 in distributions). A "reasonable salary" must reflect what an independent employer would pay for similar executive and operational duties in your geographic market.