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Sole Proprietor or S Corporation?

Could a simple entity change save you money on taxes? Let's examine the numbers together to find out.

Self Employed Business Owner

Sam Houston is Considering an S Corporation Election

Sam Houston reviewing a contract at his desk

Sam's accountant has recommended an S corporation for years. Sam preferred the simplicity of his sole proprietorship—but how much was that simplicity costing him?

Business Income
$520,000Before wages and employer Social Security and Medicare taxes
Filing Status
Married filing jointlyNo other material household income
Entity
Professional Limited Liability CompanyA Texas PLLC providing legal services
Tax Election
Sole ProprietorshipThe PLLC's current federal tax treatment
The Benefit

A $9,245 Federal Tax Reduction

Same business. Same income. A significant reduction in federal tax.

Sole Proprietorship

Business Income
$520,000
Federal Income Tax
$93,028
Social Security and Medicare Taxes
$38,876
Combined Federal Taxes
$131,904

S Corporation

Business Income
$520,000
Federal Income Tax
$93,981
Social Security and Medicare Taxes
$28,678
Combined Federal Taxes
$122,659
Federal Tax Reduction$9,245
The Mechanism

Changing How Sam Is Paid

Sam did not earn less. He changed how the business paid him.

Sole Proprietorship$480,220Income Subject to Medicare Taxes

As a sole proprietor, Sam cannot choose how to pay himself. Instead, his Schedule C net profit is adjusted under the statutory self-employment-tax formula, resulting in $480,220 entering the calculation.

S Corporation$200,000Income Subject to Medicare Taxes

An S corporation allows Sam to change how he pays himself. As an owner-employee, he is able to pay himself a W-2 wage. This caps the amount of his income subject to Social Security and Medicare taxes.

The entity election did not change the business. It changed how much of Sam's income was exposed to Social Security and Medicare taxes.

The Breakdown

Medicare Taxes Drive the Reduction

The savings are not spread evenly. Social Security stays the same; Medicare makes the difference.

Sole Proprietorship

Social Security TaxOld-Age, Survivors, and Disability Insurance (OASDI)
$22,878
Medicare TaxHospital Insurance (HI)
$13,926
Additional Medicare Tax0.9% Medicare Surtax
$2,072
Total Social Security and Medicare Taxes$38,876

S Corporation

Social Security TaxOld-Age, Survivors, and Disability Insurance (OASDI)
$22,878
Medicare TaxHospital Insurance (HI)
$5,800
Additional Medicare Tax0.9% Medicare Surtax
$0
Total Social Security and Medicare Taxes$28,678

Sam reaches the $184,500 Social Security wage base in both cases. His $200,000 S corporation wage therefore produces no Social Security tax reduction.

The Full Picture

Time Is Money

Sam Houston reviewing tax-planning documents with a CPA at a round table

S Corporation Election Requirements

  1. Make the ElectionObtain an EIN, if needed, and timely file Form 2553.
  2. Set Reasonable CompensationDocument a W-2 wage that reflects the legal services Sam provides.
  3. Run PayrollWithhold and deposit taxes and file the required federal and Texas payroll reports.
  4. File the S Corporation ReturnPrepare Form 1120-S and Schedule K-1 in addition to Sam's individual return.
  5. Maintain Separate RecordsTrack wages, distributions, expenses, basis, and ongoing Texas filings.

Sam's decision is not simply about saving $9,245 in federal taxes. It is about determining whether he can obtain those savings without sacrificing his most valuable asset—his time.

With professional help managing the accounting, payroll, and tax filings, he may be able to do all of this and more.

In the next part of our Self Employed Business Owner series, we'll look at how to bring back a lost tax deduction to bring even more tax savings home.

Methodology & Limits

What This Example Assumes—and Leaves Out.

  • $520,000 is the business-income figure used throughout the comparison, before Sam's S corporation wages and employer Social Security and Medicare taxes.
  • Sam and spouse file jointly, use the $32,200 standard deduction, and have no net capital gain or other material income.
  • The model assumes, without determining, that $200,000 is reasonable compensation and includes $14,339 of employer Social Security and Medicare tax. An actual compensation analysis could produce a different wage and tax result.
  • The model excludes FUTA, state unemployment, state franchise taxes, retirement contributions, health insurance, and entity-administration costs.
  • Differences are calculated using unrounded amounts and may not equal the difference between displayed rounded figures. Actual returns may also differ because of facts not included in this example.

Primary References

  1. 2026 Social Security contribution and benefit base
  2. IRS Social Security and Medicare withholding rates
  3. IRS S corporation compensation guidance
  4. IRS 2026 inflation adjustments

This article is educational and is not individual tax, legal, accounting, or compensation advice. Entity elections and reasonable compensation should be coordinated with a CPA and attorney.

Next Step

Model the Whole Return before Changing the Entity.

A useful comparison starts with reasonable compensation and ends after the income-tax offsets and operating costs are counted.

  • Document the compensation analysis.
  • Coordinate the election with tax and legal advisors.
  • Revisit the calculation when income or household facts change.
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