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The internet is flooded with advice about converting your single-member LLC (SMLLC) to an S-corp election. Much of it is wrong.
You'll hear people say "convert when you hit $60K in income" or "S-corps save you tons on self-employment tax!" These oversimplified rules ignore the nuanced reality of when this election actually creates meaningful value.
After analyzing countless conversion scenarios for business owners across the country, here's what we've learned: the decision is far more complex than the cookie-cutter advice suggests, and the inclusion of retirement planning completely changes the calculus.
When you make an S-corp election for your SMLLC, you're fundamentally changing how the IRS views your business income:
As an SMLLC: All your business profit is subject to self-employment tax (15.3% on the first $168,600 in 2025), plus regular income taxes.
As an S-corp: You must pay yourself a "reasonable salary" subject to payroll taxes, but any remaining profit flows through as distributions that avoid self-employment tax.
The theoretical savings come from that difference — distributions aren't hit with the 15.3% SE tax that would otherwise apply to all your LLC income.
Let's cut through the theory and look at what actually happens across different income levels when focusing purely on federal taxes, assuming you're maximizing retirement contributions (because if you're not, you're leaving money on the table).
Net benefit: $6,025 in federal tax savings + $19,057 in additional retirement contributions
This massive retirement contribution advantage makes S-corp elections extremely compelling even at moderate income levels.
Net benefit: $13,376 in federal tax savings + $14,614 in additional retirement contributions
At this income level, the S-corp election becomes compelling for virtually all business owners.
Net benefit: $16,711 in federal tax savings - $1,772 LESS retirement contribution capacity
Interestingly, at this income level the SEP-IRA actually allows slightly higher contributions, but the SE tax savings more than compensate.
Net benefit: $10,226 in federal tax savings + $0 difference in retirement contributions
At high income levels, both retirement plans hit the same ceiling, so you're only getting the SE tax savings — which may not justify the added complexity.
Here's what most advisors miss: the Solo 401(k) employee deferral capability creates massive value at lower to moderate income levels.
Unlike SEP-IRAs, Solo 401(k) plans allow you to contribute up to $23,500 as an employee deferral (in 2025). At a $75K income level, this means you can contribute over $30K to retirement vs. under $13K with a SEP-IRA — a difference of more than $19,000 annually.
This employee deferral advantage diminishes as income rises because SEP-IRA contributions scale with income, while the $23,500 employee deferral remains fixed. But for most business owners earning under $200K, the retirement contribution advantage alone justifies the S-corp election.
You'll often hear that SEP-IRAs allow "25% of compensation" contributions. This is misleading for self-employed individuals.
The reality is more complex due to a circular calculation problem. Your "compensation" for SEP purposes is defined as:
Net SE Income - SE Tax - SEP Contribution
Notice the issue? The SEP contribution appears on both sides of the equation. Solving this mathematically:
Example with $100K income:
This is why our SEP calculations use 20% — it's the mathematically correct shortcut that accounts for the circular nature of the contribution formula. Most people overestimate their SEP contribution capacity by using 25% incorrectly, making the Solo 401(k) advantage even more pronounced than they realize.
Income Below $75K: Administrative costs ($4,500+ annually for payroll processing and 1120-S preparation) eat most of the benefits, and retirement contribution advantages are minimal.
Irregular Income: If your business income swings wildly year-to-year, the S-corp structure's rigidity can create more problems than benefits.
Multiple Owners Coming: If you plan to bring in business partners, LLCs offer far more flexibility for different ownership structures and profit-sharing arrangements.
International Plans: If you're considering foreign expansion or have international clients, LLCs generally provide better tax flexibility.
High Administrative Aversion: If the thought of monthly payroll processing and quarterly filings makes you want to stick your head in the sand, stay with the LLC. The stress isn't worth the savings.
The biggest risk in S-corp elections isn't the IRS disallowing the structure — it's getting hit with penalties for paying yourself an unreasonably low salary.
Safe Harbor Guidelines:
Audit Red Flags:
The IRS increasingly scrutinizes S-corp salary levels, especially for high-income service providers. Be conservative.
Timing the Election: You can make the S-corp election up to 2 months and 15 days after the start of the tax year you want it to take effect. This gives you time to see how the year shapes up.
State Considerations: This analysis focuses on federal taxes only. States handle S-corp elections differently — some don't recognize them at all, others impose additional taxes. Factor in your state's specific rules when making the decision.
Exit Planning: S-corp structure can facilitate certain types of business sales or investment transactions more efficiently than LLCs.
Family Planning: If you're planning to bring family members into the business, S-corps offer some advantages for income shifting strategies.
The SMLLC to S-corp conversion sweet spot is narrower than most people think, but the benefits can be substantial when you hit it right.
Convert when:
Stay with the LLC when:
The key insight: It's not just about self-employment tax savings. The retirement contribution advantages often provide equal or greater value, especially when considering the immediate federal tax deduction on those additional contributions.
Don't make this decision based on internet rules of thumb. Run the numbers for your specific situation, factor in your retirement planning goals and state tax implications, and consider where your business is headed over the next 3-5 years.
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Have questions about whether an S-corp election makes sense for your situation? The analysis gets complex quickly when you factor in state taxes, retirement planning, and reasonable salary requirements. Consider working with a tax advisor who understands the nuances before making the switch.
