Definition
A tax election, not a separate kind of business, that an LLC or corporation can make with the IRS. The business remains a pass-through, but an owner who works in it must be paid a reasonable salary through payroll, subject to Social Security and Medicare taxes, and only the profit left after that salary is distributed to the owner free of self-employment tax.
Why it matters
The S election is the main lever a profitable solo business has to reduce self-employment tax, but it adds a payroll service, a separate business tax return, and state fees, so it only pays off above a certain profit level. Setting the salary unreasonably low to maximize the savings is the classic audit trigger.
Example
A consultant nets $150,000 a year. As a sole proprietor, self-employment tax applies to nearly all of it. After electing S corporation status she pays herself an $80,000 salary and takes the remaining $70,000 as a distribution, avoiding roughly 15% self-employment tax on that $70,000, about $10,000 a year, minus perhaps $2,500 for payroll processing and the extra tax return.
Put it into practice
Related terms
Limited liability company (LLC)Pass-through incomeSelf-employment taxQualified business income (QBI) deduction
This definition is educational, not financial, legal, or tax advice. U.S. rules and limits change; verify time-sensitive details with official sources. See our disclaimer.