Trap 7 · The election · From Chapter 9
S-Corp vs LLC: The Election, Not the Entity
An LLC is a state-law company; S-corp is a federal tax election. The most common S-corp in America is an LLC with Form 2553 on file — same company, different tax math — trading self-employment tax on the full profit for payroll tax on a reasonable salary plus distributions of the rest.
| LLC default | LLC + Form 2553 | |
|---|---|---|
| Employment tax base | Full profit (SE tax) | Salary only (payroll) |
| Owner pay | Draws, no W-2 | W-2 salary + distributions |
| Overhead | Minimal | Payroll + filings |
| Best when | Early / lean profit | Profit justifies payroll |
The election
An LLC becomes an S-corp for tax purposes by filing Form 2553 — nothing changes at the state, and the liability shield stays put. The S eligibility rules come with the election: 100 or fewer shareholders, one class of stock, and qualifying owners only. See S Election Eligibility.
The SE tax contrast
LLC members generally owe self-employment tax on the business profit; S shareholders owe payroll tax only on the W-2 salary, not on distributions. The trade has a price: the salary must be reasonable for the work performed — see Reasonable Compensation — and payroll must actually run.
The QSUB note
An S corporation that owns another eligible domestic corporation can elect to treat it as a qualified subchapter S subsidiary under §1361(b)(3), collapsing parent and subsidiary into a single S-corp for tax purposes. One return, one election, no second entity to feed.
Trap questions, answered
- Do I need to form a corporation to be an S-corp?
- No — an LLC files Form 2553 and is taxed as an S-corp. The S election rides on top of the state entity.
- Does the S election save self-employment tax?
- On profit above a reasonable salary, yes — distributions escape payroll tax. But the salary itself still bears payroll tax, and it must be defensible.
- What is a QSUB?
- A qualified subchapter S subsidiary: an S-corp’s wholly owned domestic subsidiary the parent elects to disregard, so the two are taxed as one. See §1361(b)(3).
The law: 26 U.S.C. § 1361 · 26 U.S.C. § 1362 · Chapter 9
From the practice: S-corp vs LLC, compared
The other traps: Reasonable Compensation · Distributions vs Salary · S Election Eligibility · Late S Election Relief