Tax TalksBusiness OwnersUpdated July 21, 2026

Sole Proprietor or S Corporation?

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

The 2026 Case

Mr. Houston Works as a Contract Attorney.

Sam Houston reviewing a contract at his desk

Business Income

$200,000The amount used throughout this comparison

Filing Status

Married filing jointlyNo other material household income

S Corporation Wage

$100,000Assumed reasonable solely for this illustration

Trade

Contract AttorneyA Specified Service Trade or Business (SSTB)

In this fictitious example, Sam Houston is debating whether to continue operating as a sole proprietor, reporting his business income on Schedule C, or to form a single-member LLC and elect for it to be taxed as a S corporation. His accountant told him that a S corporation election could reduce his payroll taxes, and he is curious how that might work.

Reasonable Income

Lowering Your Payroll Taxes

Wouldn't it be nice to lower the wages used in calculating your Payroll taxes? A S corporation can do just this by using W-2 wages for Sam. As long as the W-2 wages reasonably reflect the owner's services, less income from the business enters the Payroll tax calculation. Let's take a look together.

$184,700Income Subject to Payroll 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 $184,700 entering the calculation.

$100,000Income Subject to Payroll Taxes

A S corporation allows Sam to change how he pays himself. As an owner-employee, he must receive a reasonable W-2 wage before taking non-wage distributions. In this case study, payroll taxes apply to the $100,000 modeled wage.

Old-Age, Survivors, and Disability Insurance (OASDI)

Social Security Tax

Sole Proprietor$22,878Social Security tax

S Corporation$12,400Social Security tax

Tax Savings$10,478in this case study

Sam reaches the $184,500 Social Security wage base as a sole proprietor. His $100,000 S corporation wage does not, creating $10,478 of Social Security tax reduction.

A black-and-gold ballpoint pen resting across an accounting ledger

Hospital Insurance (HI)

Medicare Tax

$5,356Sole Proprietor Medicare Tax

2.9% of $184,700 of net earnings from self-employment.

$2,900S Corporation Medicare Tax

2.9% combined employer and employee tax on $100,000.

Medicare has no wage ceiling. The S corporation therefore saves another $2,456 by applying the tax to Sam’s $100,000 wage rather than $184,700 of net earnings from self-employment. Neither case reaches the $250,000 joint Additional Medicare Tax threshold.

Section 199A

It's Not All Roses

By changing how he pays himself, Sam actually loses part of the Qualified Business Income deduction that he had before.

Section 199A StepSole ProprietorS Corporation

Qualified Business Income$185,883$92,350

Taxable Income before Section 199A$153,683$160,150

Modeled Section 199A Deduction$30,737$18,470

The S corporation reduces the modeled Section 199A deduction by about $12,267. Together with the different payroll-tax deductions, regular federal income tax rises by about $4,121.

The Full Picture

An $8,813 Federal Tax Reduction

Federal Income Tax After the QBI Deduction

Sole Proprietor: $16,472
S Corporation: $20,594
S Corporation Detriment: ($4,121)

Social Security and Medicare Taxes

Sole Proprietor: $28,234
S Corporation: $15,300
S Corporation Benefit: $12,934

Modeled Federal Tax Total

Sole Proprietor: $44,706
S Corporation: $35,894
S Corporation Modeled Federal Tax Reduction: $8,813

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

Now, this isn't the whole picture. If Mr. Houston enacts this change, it will necessitate additional work and tax filings. He'll need to run payroll, file Form 1120-S and related payroll returns, handle applicable state filings, and begin bookkeeping. However, with $8,813 in modeled tax savings, Sam—and other business owners—will likely be interested.

Talk with your tax professional to determine whether the modeled savings exceed the ongoing costs and how their services can help manage the additional work.

Methodology & Limits

What This Example Assumes—and Leaves Out.

$200,000 is the business-income figure used throughout the comparison.
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 $100,000 is reasonable compensation and includes $7,650 of employer Social Security and Medicare tax. An actual compensation analysis could produce a higher wage and lower tax savings.
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 modeled here.

Primary References

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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