Setting the Record Straight on S Corporations

Brian Kearns, CPA, CFP, RIA Founder, Haddam Road Advisors
Best Practices in Financial Planning

I‘ve seen all kinds of memes on social media lately about S corporations.

Many of these contain titles like, “How the Rich Use S Corps to Explode Their Wealth!” and “Switch Your LLC to an S Corp for HUGE Tax Savings!” Many business owners I’ve met talk about the S corporation election as a means to reduced self-employment taxes. But the S corporation election can be way more complex than just minimizing the effect of a payroll tax, and it’s our job as fiduciaries to communicate that to a broader audience.

Yes, minimizing the unpleasantness of a 15.3% levy for self-employment is very attractive. After all, one can easily see the allure of “HUGE Tax Savings!” But going from the flow-through taxation of a limited liability company (LLC) to an S corporation carries other ramifications that, down-the-line, can have real adverse tax consequences for a business owner if handled improperly.

In other words, considering S corporation status requires a decades-long view. This is especially true for startups, whose future appreciating assets will be impacted by their entity structure and long-term tax planning.

As a certified public accountant (CPA), you can play a key role in helping your clients determine if crossing the realm of 1040 personal taxation into the corporate tax and legal system makes sense for them. Here are a few insights to consider.

Does the Math Make Sense?

The S corporation election should be considered on a case-by-case basis. It’s important to keep in mind that once a client goes over the Federal Insurance Contributions Act limits ($176,100 for 2025), the self-employment tax issue has less impact and may not make a material difference in the final tax bill.

Now that the 20% qualified business income deduction (QBID) is permanent, there’s also a balancing act to consider between minimizing self-employment tax and maximizing the QBID. For example, S corporation owners who are working in the business receive a salary for services performed and flow-through income based on their ownership percentage. However, the salary paid to the S corporation shareholder isn’t considered qualified business income. A key difference is that an LLC owner’s entire share of the business’ ordinary income is considered qualified business income, and there’s no exclusion for a salary. This could potentially result in a higher QBID. Conversely, W-2 wages (which an S corporation is required to pay) can sometimes enable a larger QBID than an LLC owner would receive. However, this depends on the specific income level and business characteristics.

Also, don’t forget—different states do things differently. For instance, in Illinois, S corporations are subject to a 1.5% entity-level tax on flow-through income. This offsets the benefit of S corporation non-salary distributions not being subject to the 1.45% Medicare tax.

Additionally, your clients need to consider the balance sheet. It’s not overly dramatic to say that a cornerstone of the future after-tax value of a business starts with entity selection and continues with asset placement in the proper entity. Remember, a client’s business may be new and growing year after year, but they need to weigh whether the restrictions of an S corporation election are worth the limited advantage of lower self-employment tax.

Try to Keep Real Property Out of It

While it’s true that the pass-through nature of a LLC allows for greater flexibility in managing the allocation of income, losses, and distributions, it’s common practice to keep real property out of S corporations.

“Real property can generally be distributed from an LLC partnership or LLC disregarded to the member(s) without tax consequence. But when appreciated assets are distributed out of an S corporation—to the extent the value of the asset exceeds its adjusted basis—the entity will recognize gain, which will be passed through to the shareholder(s) or, in an LLC that’s taxed as an S corporation, to the member(s),” explains Jessica Oldani of Oldani Entrepreneurial Law PC. “Typically, business owners don’t wish to pay tax on the gain from receipt of assets developed in their own businesses.”

Real and tangible assets are usually easy for owners to envision as appreciable property, but intangible assets may be the things that accelerate in value at a breathtaking rate. Think of it this way: There was a time when people didn’t say, “I’ll have a Coke,” “Let’s Google it,” or “I’ll take an Uber.” Yet, these are now multibillion-dollar words.

“These days, the majority of business value consists of intellectual assets. Most businesses, even the smallest, have brand names, logos, databases, processes, expertise, websites, and other original content. We expect all this intellectual property to appreciate, and often, it’s self-created,” Oldani stresses.

She adds that many entrepreneurs have big plans for growth and expansion or for the eventual sale of their businesses and may benefit from staying flexible in order to move things around as needed, including to potentially distribute certain intellectual property to themselves (e.g., using it to consult for a few hours per month in retirement).

“We’re thoughtful before making an S corporation election that might make things more difficult and costly for our clients in the long run,” Oldani says. “If our clients need to minimize self-employment tax or include W-2 wages in the tax equation, there are multiple strategies to consider—an S corporation election might be among them, but the client needs the full picture to make an educated decision.”

The S Corporation Election Is a One-Way Ticket

Oldani stresses that for an LLC taxed as an S corporation, you can’t just revoke your S corporation election to get back to your original LLC tax type. “I can get you back into a partnership LLC or disregarded LLC, but I have to do some legal gymnastics to get you there.”

As she further explains, “When you make your S corporation election, the IRS deems you to have first made a C corporation election underneath it. So, if you revoke or lose your S corporation election, you end up as an LLC taxed as a C corporation, not your original pass-through LLC.”

Be Careful With Agreements

Lastly, when making the S corporation election, owners must be mindful of the LLC operating agreement. For instance, Oldani says that if language in the operating agreement isn’t aligned with the S corporation requirements, it needs to be updated to preserve the election. Suffice it to say, considering an S corporation election requires more than a very narrow employment tax withholding lens.

Overall, while electing S corporation status can provide some real benefits to certain businesses, it isn’t the solution for every client. CPAs need to work with a good business lawyer and proactive financial planner and advisor to counter the recent viral ‘’HUGE Tax Savings” narratives with balanced, asset-aware guidance.

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