What an S Corp Actually Changes
As a sole proprietor or single-member LLC, all your freelance profit shows up on Schedule C and gets hit with the full 15.3% self-employment tax (Social Security and Medicare) through Schedule SE, on top of income tax. An S corp does not eliminate that tax, but it changes how much of your income is subject to it.
With an S corp, you become an employee of your own business. You pay yourself a reasonable salary through payroll (with taxes withheld and reported on a W-2), and any remaining profit gets distributed to you separately. Only the salary portion is subject to Social Security and Medicare taxes. The distribution portion is not. That split is where the savings come from.
When the Math Works
Here is a rough example. Say your freelance business nets $80,000 in profit for the year. As a sole proprietor, roughly all of that is subject to the 15.3% self-employment tax. As an S corp, you might pay yourself a reasonable salary of $45,000 (subject to payroll tax) and take the remaining $35,000 as a distribution (not subject to that tax). That can save several thousand dollars a year.
But the IRS requires the salary to be "reasonable" for the work you do, not artificially low just to dodge taxes. Underpaying yourself to shrink payroll tax is a common audit trigger.
The savings only start to outweigh the costs once net profit is consistently in the $40,000 to $60,000 range or higher. Below that, the numbers rarely justify the switch.
The Costs Nobody Mentions
An S corp is not free to run. You will likely need:
- A payroll system to pay yourself a W-2 salary, with quarterly payroll tax filings (Form 941)
- A separate business tax return, Form 1120-S, in addition to your personal return
- More detailed bookkeeping since business and personal money must stay cleanly separated
- Possibly a tax professional to handle the S corp return and payroll setup, since these are harder to DIY than a simple Schedule C
Some states also charge extra franchise or minimum taxes just for having an S corp on the books. Add these costs up before assuming the S corp saves money, some freelancers spend $2,000 to $4,000 a year on payroll and extra tax prep just to unlock the savings.
How to Decide
Start by looking at your last twelve months of net profit after expenses, not your gross revenue. If that number is inconsistent, feast or famine style, an S corp adds fixed costs (payroll, filings) you have to cover even in slow months. Steady, predictable profit is a much better fit than sporadic income.
If you are still forming an LLC for liability protection, know that the LLC and the S corp decision are separate. You can form an LLC now for legal protection and elect S corp tax treatment later, using Form 2553, once your profit justifies it. There is no need to rush into S corp status the moment you start freelancing.
If you are already making quarterly estimated payments with Form 1040-ES and profit has been solidly above $50,000 for a year or two, that is the point to run the actual numbers with a tax professional rather than guessing.