S-Corp Election: Self-Employment Tax Savings and Compliance Requirements

S-corporation status can save thousands in self-employment tax by splitting income between salary and distributions. However, payroll processing, reasonable compensation documentation, and corporate returns add complexity and cost.

The core tax advantage is the salary/distribution split. As an S-corp owner-employee, you pay yourself a reasonable salary (subject to FICA/Medicare withholding) and take remaining profits as distributions, which are not subject to self-employment tax. On $120,000 of profit with a $70,000 salary, you avoid roughly $7,065 in SE tax compared to a sole proprietorship.

Payroll is mandatory, not optional. You must run payroll for yourself and any employees, withhold federal and state taxes, pay employer FICA, file quarterly Form 941, and issue W-2s. Payroll services cost $500-$2,000 per year. Skipping payroll when taking distributions is a red flag the IRS actively pursues.

Reasonable compensation is the audit trigger. The IRS looks at officer compensation on every S-corp return. Setting your salary too low invites reclassification of distributions as wages, plus back taxes, penalties, and interest. Your CPA should benchmark your salary against industry and geographic data.

Additional filing requirements. The S-corp files Form 1120-S (separate from your personal return) and issues K-1s to shareholders. Most states require a separate state return as well.

The tradeoff: S-corp status saves self-employment tax but adds payroll, a corporate return, stricter recordkeeping, and annual CPA costs of $1,500-$3,000+. The math only works when net profits consistently exceed $50,000-$60,000.