“Should I be an LLC or an S-corp?” is one of the most common questions service and software founders ask — and one of the easiest to get wrong. The short answer: LLC and S-corp aren’t the same kind of thing. An LLC is a legal entity; an S-corp is a tax election. You can be an LLC that’s taxed as an S-corp. Here’s what actually matters for an agency, consultancy, or SaaS company — especially in high-tax California and franchise-tax Texas.
LLC vs. S-corp: the real distinction
An LLC gives you liability protection and, by default, “pass-through” taxation — profits flow to your personal return and you pay income tax plus self-employment tax (15.3%) on the entire profit. An S-corp election changes how you’re taxed: you pay yourself a reasonable salary (subject to payroll taxes), and the remaining profit is distributed without self-employment tax. That split is where the savings come from.
When the S-corp election pays off
There’s a break-even. Below roughly $60,000–$80,000 of net profit, the payroll setup, extra tax filings, and administrative cost often outweigh the savings. Above it, the math usually tips in favor of electing S-corp status. Two requirements make or break it:
- Reasonable salary: the IRS requires S-corp owners to pay themselves a defensible market wage before taking distributions. Pay yourself too little and you invite an audit; too much and you erase the savings.
- Real payroll: you must run actual payroll with withholding — which means a payroll system and quarterly filings.
California: the S-corp tax and the $800 floor
California is where this decision gets expensive if you’re not careful. California imposes a 1.5% tax on S-corp net income (minimum $800), and the $800 annual minimum franchise tax applies to LLCs and corporations regardless of profit. So a California S-corp owner weighs federal self-employment-tax savings against California’s 1.5% entity tax. Often it still wins — and the AB 150 PTE elective tax can layer on additional federal savings. Our California CPA team models this for each client rather than guessing.
Texas: no income tax, but mind the franchise tax
Texas has no state income tax, so the S-corp decision is driven almost entirely by federal self-employment-tax savings — cleaner than California. But both LLCs and S-corps must file the Texas Franchise (margin) tax report, and the entity type can affect the margin calculation. Our Texas team handles the election and the filings together.
So which should you choose?
A practical rule of thumb for service & software businesses:
- Just starting / low profit: an LLC (taxed as a sole prop or partnership) is simple and cheap.
- Consistently profitable (roughly $70k+ net): stay an LLC legally, but make the S-corp tax election to cut self-employment tax.
- Raising venture capital: a Delaware C-corp is usually expected — a separate conversation worth having early.
We help founders pick the structure, file the election on time, set a defensible salary, and run the payroll — as part of tax planning and monthly bookkeeping.
Get a free entity-structure consultation →
Frequently asked questions
Is an S-corp a type of company?
No. An S-corp is a federal tax election. You typically form an LLC (or corporation) and then elect to be taxed as an S-corp by filing IRS Form 2553.
How much can an S-corp election save?
It depends on your profit and your reasonable salary, but profitable owners commonly save several thousand dollars a year in self-employment tax. Below about $60k–$80k of net profit, the costs often outweigh the savings.
Does California make S-corps less worthwhile?
California’s 1.5% S-corp tax reduces the benefit but usually doesn’t eliminate it, and the AB 150 PTE election can add savings. It should be modeled per business.
Do I still file Texas franchise tax as an S-corp?
Yes. Most Texas entities, including S-corps and LLCs, must file the annual Franchise Tax report even if no tax is due.
This is general information, not tax or legal advice. Entity and tax rules change and depend on your specifics — confirm with a CPA before electing.
