S-Corp vs LLC for Contractors — The Tax Math Nobody Shows You

The $15,300 Check You're Writing the IRS Every Year

If you're running an HVAC, plumbing, or electrical business as a single-member LLC or sole proprietor and netting over $80,000 a year, there's a reasonable chance you're leaving $10,000-$25,000 on the table in unnecessary taxes. Every year.

This isn't a loophole. It's a structural difference in how the IRS treats business income depending on your entity type — and it's one of the most common and most expensive gaps I see when reviewing contractor financials. Having interviewed and reviewed the books of hundreds of contractors across HVAC, plumbing, electrical, and mechanical — both at BuildOps and now at Level — the pattern was consistent: most owners knew they "should probably look at an S-Corp" but hadn't done the math. The math, once you see it, makes the decision obvious.

Let me walk you through it.

The Core Difference: Self-Employment Tax

When you operate as a sole proprietor or single-member LLC, the IRS treats your entire net profit as self-employment income. You pay both sides of Social Security and Medicare on every dollar — the employee's share and the employer's share. That's 15.3% on the first $176,100 of net earnings (the 2025 Social Security wage base, which adjusts annually), plus 2.9% Medicare on everything above that (plus the 0.9% Additional Medicare Tax if you're over $200K individually).

On $200,000 in net profit as an LLC, you're paying roughly $28,200 in self-employment tax before a single dollar of income tax. That's your burden.

An S-Corp changes the structure. Your business income passes through to you in two buckets: a W-2 salary (subject to payroll taxes) and distributions (not subject to payroll taxes). You still pay self-employment taxes on the salary portion — but not on the distributions. The entire game is about sizing the salary appropriately.

The Math at Three Income Levels

Let me run the numbers. These use 2025 tax rates and a married filing jointly scenario.

Scenario 1: $100,000 Net Profit

As LLC (SE Tax):

• Net profit: $100,000
• SE tax (15.3% on $100K): $15,300
• SE tax deduction (half of SE tax): -$7,650
• Adjusted income: $92,350
• Federal income tax (22% bracket MFJ): ~$20,317
• Total tax burden: ~$35,617

As S-Corp (reasonable salary: $50,000):

• Salary: $50,000 (payroll taxes: $7,650 — split employer/employee)
• Distribution: $50,000 (no payroll taxes)
• Total payroll tax: $7,650
• Federal income tax on ~$92,350 equivalent income: ~$20,317
• Total tax burden: ~$27,967
• Savings: ~$7,350/yr

At $100K, the S-Corp saves you roughly $7,000-$8,000 annually. That number alone covers the cost of running payroll and filing the additional tax return, with money left over.

Scenario 2: $200,000 Net Profit

As LLC:

• SE tax on $176,100 (SS wage base): $26,943
• SE tax on remaining $23,900 (Medicare only at 2.9%): $693
• Total SE tax: ~$27,636
• Effective SE tax rate on $200K: 13.8%

As S-Corp (reasonable salary: $85,000):

• Payroll taxes on $85K: $13,005
• Distribution: $115,000 — zero payroll tax
• Total payroll tax: $13,005
• Savings: ~$14,631/yr

At $200K net, you're saving roughly $14,000-$15,000 per year. The S-Corp setup costs $1,500-$3,000 to establish and $2,000-$4,000 per year to maintain (payroll, bookkeeping, additional tax return). You're still netting $10,000+ annually after costs.

Scenario 3: $500,000 Net Profit

As LLC:

• SE tax on $176,100: $26,943
• Medicare on remaining $323,900 at 2.9%: $9,393
• Additional Medicare Tax on income over $200K (0.9%): $2,691
• Total SE/Medicare tax: ~$39,027

As S-Corp (reasonable salary: $130,000):

• Payroll taxes on $130K: $19,890 (SS caps at $176,100, so full SS applies)
• Distribution: $370,000 — no payroll taxes
• Total payroll tax: ~$19,890
• Savings: ~$19,137/yr

At $500K, the savings plateau somewhat — above the Social Security wage base, the LLC is only paying 2.9% Medicare plus 0.9% additional, not the full 15.3%. But you're still saving $19,000+ annually just on payroll taxes.

The Reasonable Salary Requirement — and the IRS

The IRS knows this game. Their requirement is that S-Corp owners who work in the business must pay themselves a "reasonable compensation" — a salary comparable to what you'd pay someone else to do your job. This is where the structure has teeth and where sloppy implementation creates risk.

What reasonable salary looks like for contractors:

The IRS has audited and won cases where S-Corp owners paid themselves $20,000 salaries while the business generated $600,000 in profit. They reclassify the distributions as wages, assess back payroll taxes, and add penalties and interest. I've reviewed contractor books where this exact situation was sitting as a ticking clock.

The working rule: salary should be at least 40-60% of net profit at lower income levels, and can be a lower percentage at higher income levels where the excess genuinely represents return on capital rather than compensation for services. When in doubt, err higher on salary. The savings still outweigh the cost, and the audit risk drops dramatically.

If the business has multiple owners, each owner-employee needs their own reasonable salary analysis. That complexity is manageable with the right accounting setup — it just can't be handled by a bookkeeper who also does your cousin's taxes.

The QBI Deduction Complication (Section 199A)

Here's where entity choice gets genuinely complicated: the 20% Qualified Business Income deduction under Section 199A.

The QBI deduction allows pass-through business owners (including both S-Corps and LLCs) to deduct up to 20% of qualified business income, subject to limitations. The relevant limitation for contractors: above certain income thresholds ($383,900 MFJ in 2025), the deduction phases out for "specified service trades or businesses" (SSTBs) and gets limited to 50% of W-2 wages for other businesses.

Good news for most contractors: HVAC, plumbing, electrical, mechanical, and roofing are generally NOT SSTBs. You're classified as a "qualified trade or business," which means you can use the W-2 wage limitation.

The W-2 wage limitation matters: Your QBI deduction is limited to the lesser of 20% of QBI or 50% of W-2 wages paid. If you're an LLC with no W-2 wages (because you take everything as SE income), your deduction isn't limited by this — but your deduction is also potentially less valuable than if you structure W-2 wages strategically through an S-Corp.

For most contractors in the $150K-$500K net income range, the interplay between S-Corp salary and QBI is actually favorable: the salary creates W-2 wages that support a larger QBI deduction. Your tax advisor needs to model both variables simultaneously. Anyone telling you the answer without running this model is guessing.

When Staying an LLC Is Actually the Right Call

I want to be direct about when the S-Corp election doesn't make sense, because the answer isn't always "elect S-Corp immediately."

Under $60,000-$80,000 in net profit. The administrative costs of running an S-Corp — payroll service ($500-$2,000/yr), additional tax return ($800-$2,000/yr), additional bookkeeping complexity — often consume the SE tax savings entirely. At $60K net, you're saving roughly $4,000-$5,000 in SE tax. After costs, the net benefit is marginal. The math gets better above $80K, and compelling above $100K.

You're planning to raise outside capital. S-Corps cannot have more than 100 shareholders, cannot have non-US citizen shareholders, cannot have corporate shareholders, and cannot issue multiple classes of stock. If you're positioning for institutional capital — even venture or PE down the road — you'll need to convert to a C-Corp anyway. An S-Corp is a detour. Start as an LLC, plan the conversion carefully.

Specific state tax situations. California, for example, levies a 1.5% franchise tax on S-Corp net income on top of federal taxes, with a minimum $800 floor. In California, the S-Corp benefit is reduced. New York City has a similar issue — the city doesn't recognize S-Corp status for its purposes, meaning you pay city tax on the full business income. Run your state-specific math before assuming the federal savings translate.

You're actively losing money. If net profit is negative, there's no SE tax to avoid. Focus on fixing the business before optimizing its structure. The two cleanest indicators that you're ready for this conversation: profitable for at least two consecutive years, and net income consistently above $80K. The structure exists to protect profits — you need consistent profits first.

The Mechanics of Electing S-Corp

If you're already an LLC, you don't need to re-form the entity. You file Form 2553 with the IRS to elect S-Corp tax treatment on an existing LLC. The LLC structure remains intact — the S-Corp election is a tax classification, not a legal change.

Key deadlines: For a given tax year, you must file by March 15 of that year (for calendar year businesses) or within 75 days of formation for a new business. Late elections are sometimes accepted with a reasonable cause explanation, but don't count on it.

Once elected, you'll need: a payroll service for W-2 processing, a separate business bank account (you should have this anyway), and a CPA who files Form 1120-S (the S-Corp return) in addition to your personal 1040. Most tax preparers who work with small businesses handle this. The complexity isn't dramatic — it's just more paperwork and a few hundred dollars more in accounting fees annually.

The annual administrative tasks: run payroll at least quarterly (some states require monthly), file Form 941 quarterly (federal payroll taxes), file W-2/W-3 by January 31, file Form 1120-S by March 15.

What This Means for Your Business Value

If you're thinking about selling your contracting business in the next 5-10 years, entity structure matters beyond the annual tax savings.

When PE firms evaluate contractor financials, they look at EBITDA. Owner W-2 compensation shows up as an expense, which reduces reported EBITDA. Distributions don't. The add-back analysis — where PE firms add back excess owner compensation — is more straightforward when the compensation structure is defensible and documented. A well-structured S-Corp with documented reasonable salary and consistent distributions tells a cleaner story than an LLC with erratic owner draws.

It's also worth noting that fractional CFO support starts making sense at the same income levels where the S-Corp election is compelling. The two often coincide: once you're doing $3M+ in revenue and netting $150K+, you've outgrown DIY bookkeeping and DIY tax planning simultaneously.

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The Bottom Line

The decision framework is simple: if you're a contractor netting over $80,000/year in a state without punitive S-Corp treatment, the election almost certainly makes financial sense. The savings are real ($7,000-$25,000 annually depending on income level), the setup is manageable, and the IRS audit risk is minimal when the salary is defensible.

The mistakes I see are: waiting too long (every year as an LLC above $80K is years of unnecessary SE tax), setting salary too low (a $25K salary on $500K of profit will attract IRS attention), and ignoring the QBI interaction (which can cut either way depending on your income level).

Run the numbers for your situation. If you haven't benchmarked your overall financial health recently, start there — the entity structure optimization only matters if the underlying business is generating the margins to make it worthwhile.

Q: When exactly should I elect S-Corp for my contracting business? A: The standard threshold is $80,000-$100,000 in net profit annually, after paying yourself a reasonable salary. Below that, the administrative costs ($1,500-$3,000/yr) often outweigh the SE tax savings. Above that, the savings typically exceed costs by a material amount — $5,000 to $20,000+ per year depending on income. The best time to make the change is at the start of a tax year, so plan ahead. If you're already profitable above $100K as an LLC, you should revisit this immediately.

Q: How do I know if my S-Corp salary is reasonable? A: The IRS looks at what you'd pay a third party to do your job. For most contractor-owners running day-to-day operations, that's $70,000-$130,000 depending on revenue size and scope. BLS Occupational Employment Statistics publishes salary data by role that the IRS references. A good rule of thumb: salary should be at least 40% of S-Corp profits, and should increase as the business grows. Keep documentation — job description, salary survey comparisons — in case you're ever asked to defend it.

Q: Does switching to S-Corp affect my ability to get bonding or financing? A: It shouldn't, but context matters. Bonding companies and lenders look at personal income, business cash flow, and net worth. A well-documented S-Corp with clean financials — W-2 income plus distributions clearly shown on K-1 — is straightforward to underwrite. The confusion sometimes arises when distributions aren't reflected in the personal income lenders want to see. Make sure your CPA documents the full income picture clearly, and read our bonding capacity financial playbook for the specifics of how bonding companies underwrite contractor financials.