Guide for freelancers

Sole Proprietor vs. LLC vs. S-Corp: Which Should You Choose?

Q: How does an S-Corp actually save on self-employment tax?

You pay yourself a reasonable salary through payroll, which is subject to the 15.3% self-employment/payroll tax. The remaining profit is paid out as a distribution, which is not subject to that 15.3% tax at all — only income tax.

Q: Can I just pay myself a small salary to save more?

No. The IRS requires a 'reasonable salary' that reflects what you'd pay someone else to do your job, and increasingly flags S-Corps where distributions are disproportionately large compared to salary.

Q: Does the QBI deduction apply no matter which structure I choose?

Yes. The 20% Qualified Business Income deduction applies to sole proprietors, LLCs, and S-Corps alike, as long as you qualify under the income thresholds. It doesn't favor one structure over another.

The business structure decision every US freelancer eventually faces — and the income level where it actually starts to matter.

Most freelancers start as sole proprietors without ever deciding to — it's just what happens by default the moment you earn money on a 1099. That's fine for a while. But at some point, usually once income becomes steady, two questions come up: do I need liability protection, and am I overpaying in self-employment tax? Here's how the three common structures compare.

Sole proprietorship: the default

If you haven't filed anything with your state, this is what you are. You and your business are legally the same entity — there's no separation. You report profit on Schedule C, and all of it is subject to the full 15.3% self-employment tax, on top of income tax.

The tradeoff: zero setup cost, zero extra filings, maximum simplicity. But your personal assets — savings, car, home — aren't separated from business liabilities. If a client sues your business, they're effectively suing you.

LLC: liability protection, same tax bill

Here's the detail that surprises a lot of freelancers: forming an LLC does not, by itself, change your taxes at all. A single-member LLC is taxed exactly like a sole proprietorship by default — same Schedule C, same 15.3% self-employment tax on the full profit. What it does give you is a legal separation between your personal assets and business debts or lawsuits.

Cost: $50 to $500 in state filing fees, plus annual renewal fees that vary by state. Some states add their own twist — California, for example, charges an $800 minimum annual franchise tax regardless of income.
Best for: freelancers who want liability protection now but don't yet have the income to justify the extra cost of an S-Corp election.

An LLC can also elect to be taxed as an S-Corp — the entity and the tax election are two separate decisions, which is where the next option comes in.

S-Corp election: where the tax savings actually come from

An S-Corp isn't a different type of business entity on its own — it's a tax election (via Form 2553) that an LLC or corporation can make. The mechanism: instead of your entire net profit being hit with 15.3% self-employment tax, you split it into two buckets.

Reasonable salary — paid to yourself through payroll, subject to the full 15.3%.
Distributions — the remaining profit, paid out with no self-employment tax at all (though still subject to regular income tax).

Worked example: a freelancer earning $120,000 in net profit pays a reasonable salary of $60,000 and takes the other $60,000 as a distribution. That distribution avoids self-employment tax entirely, saving roughly $9,000 a year before accounting for the added compliance costs.

The catch: "reasonable salary" isn't optional

You can't pay yourself $1 and take the rest as distributions to dodge the tax entirely. The IRS requires a reasonable salary — one that reflects what you'd have to pay someone else to do your job — and its data matching increasingly flags S-Corps where distributions look disproportionately large next to salary. The general benchmark: look at what the role would pay as a W-2 position in your industry and region.

When does the S-Corp election actually pay off?

Most sources put the break-even point around $50,000 to $80,000 in net profit per year. Below that range, the added costs tend to eat up the savings:

Payroll processing to pay yourself a W-2 salary.
A separate corporate tax return (Form 1120-S), commonly $1,000 to $1,500 or more if you use a preparer.
Ongoing bookkeeping to keep salary and distributions properly documented.

Above that income level, the math tends to flip: S-Corp owners commonly report savings in the $5,000 to $15,000 range annually, and the gap widens as profit grows.

One thing that doesn't change: the QBI deduction

The 20% Qualified Business Income deduction applies whether you're a sole proprietor, an LLC, or an S-Corp — it doesn't favor any one structure. Don't let it factor into this specific decision; it's already part of the calculation either way, as long as you qualify under the income thresholds.

A simple way to think about it

Under roughly $30,000 net profit: sole proprietorship is usually fine. The liability risk in most service-based freelance work is low, and the LLC cost isn't worth it yet.
$30,000–$50,000: an LLC starts to make sense for the liability protection alone, even without an S-Corp election.
$50,000–$80,000+: this is where it's worth running the numbers on an S-Corp election with a tax professional, since the self-employment tax savings can outweigh the added compliance cost.

Know what to charge before you worry about structure

Your rate should already account for self-employment tax, federal tax, and the QBI deduction.

Go to the free calculator

Frequently asked questions

Does forming an LLC lower my taxes?

Not by itself. A single-member LLC is taxed exactly like a sole proprietorship by default: self-employment tax on all net profit. Its main benefit is liability protection, not a tax reduction.

When does an S-Corp election start saving money?

Most sources put the break-even point around $50,000 to $80,000 in net profit per year. Below that, the added payroll and filing costs tend to outweigh the savings.

How does an S-Corp actually save on self-employment tax?

You pay yourself a reasonable salary through payroll, subject to the full 15.3%. The remaining profit is paid out as a distribution, which isn't subject to that tax at all — only regular income tax.

Can I just pay myself a small salary to save more?

No. The IRS requires a "reasonable salary" reflecting what you'd pay someone else to do your job, and increasingly flags S-Corps where distributions are disproportionately large compared to salary.

Does the QBI deduction apply no matter which structure I choose?

Yes. The 20% deduction applies to sole proprietors, LLCs, and S-Corps alike, as long as you qualify under the income thresholds.

General information based on current IRS guidance on self-employment tax, S-Corp elections (Form 2553), and the QBI deduction. This is not tax or legal advice. Business structure decisions have state-specific and liability implications — talk to a CPA and, ideally, a business attorney before you file anything.