The biggest tax benefit is saving on self-employment tax. As a sole proprietor or single-member LLC, you pay 15.3% in self-employment tax (Social Security and Medicare) on all your net profit. When you elect S-corp status, you pay yourself a reasonable salary and take the remaining profit as a distribution. Payroll taxes only apply to the salary portion. The distributions pass through to your personal return but skip that 15.3% hit.

Here’s a simple example. Say your contracting business nets $150,000 in profit. As a sole proprietor, you owe roughly $21,200 in self-employment tax on top of your income tax. As an S-corp paying yourself a $75,000 salary, payroll taxes apply only to that $75,000, cutting your self-employment tax bill roughly in half. The other $75,000 still gets taxed as income, but it avoids the 15.3%.

The IRS requires that your salary be “reasonable” for the work you do. You can’t pay yourself $30,000 as a general contractor running $500,000 in revenue and take the rest as distributions. The IRS looks at what someone in your role and industry would earn, and if your salary is unreasonably low, they can reclassify your distributions as wages and hit you with back taxes and penalties. Getting this number right matters.

S-corp election generally starts making sense when your net profit consistently exceeds $80,000 to $100,000 per year. Below that threshold, the additional costs tend to eat into the savings. You’ll need to run payroll for yourself, file a separate S-corp tax return (Form 1120-S), and potentially pay higher accounting fees. Those costs can run $3,000 to $5,000 or more annually depending on your situation.

There are other benefits worth knowing about. S-corps can deduct 100% of health insurance premiums for shareholder-employees. Retirement plan contributions can be structured more favorably. And having a formal entity with clean books makes it easier to get bonding, financing, and larger contracts.

The decision isn’t just about whether S-corp saves you money today. It’s about whether it fits your business trajectory. A CPA who works with contractors can run the actual numbers for your situation and tell you exactly what you’d save after accounting for the extra compliance costs.

If you’re already running as an S-corp but aren’t sure your salary is set correctly or you’re not tracking things well enough to take full advantage of the structure, that’s worth looking at too. A proper tax strategy review can identify whether your current setup is actually optimized or just costing you extra filing fees without the full benefit.

One more thing. S-corp is a tax election, not a new entity type. If you already have an LLC, you can elect S-corp taxation by filing Form 2553 with the IRS. You don’t need to dissolve anything or start over. The election is typically made at the beginning of a tax year, so planning ahead gives you the most flexibility.