When Should a Trade Contractor Elect S-Corp Status? The Math Most CPAs Don't Show You

The S-Corp election is probably the single most impactful structural change a trade contractor can make. It's also one of the most misunderstood. I've seen contractors elect too early (wasting money on payroll overhead they didn't need), too late (paying years of unnecessary self-employment tax), and sometimes not at all because no one ever explained the math.

The Problem: Self-Employment Tax

If you're operating as a sole proprietor or a single-member LLC that hasn't made any special elections, the IRS treats all of your net business income as self-employment income. That means you pay self-employment tax — currently 15.3% — on every dollar of profit.

That 15.3% breaks down into 12.4% for Social Security (on the first $168,600 of earnings for 2024) and 2.9% for Medicare (on all earnings, with an additional 0.9% above $200K single / $250K married).

On $200K of net income, that's roughly $28,000 in self-employment tax. On $400K, it's approximately $40,000. On $300K — common in the $3-8M revenue range — self-employment tax alone runs about $35,000 per year. All of that is on top of your income tax.

The S-Corp Solution

When you elect S-Corp status, you split your business income into two categories:

Salary: You pay yourself a W-2 wage. This portion is subject to payroll taxes (the employer and employee shares of FICA — same 15.3%, split between you and the company, which is also you).

Distributions: Everything above your salary comes out as a shareholder distribution. This portion is subject to income tax but not self-employment tax.

The savings happen on the distribution side. Every dollar you can legitimately classify as a distribution instead of salary avoids the 15.3% self-employment tax bite.

Running the Real Numbers

Let's use a concrete example. You're an electrical contractor in Southern California. Your S-Corp nets $350,000 after all business expenses (but before your salary).

Scenario A: No S-Corp (Sole Proprietor / Standard LLC)

Your $350K is all self-employment income. Self-employment tax: approximately $38,500 (12.4% on first $168,600 + 2.9% on all $350K + 0.9% additional Medicare on the amount over $200K).

Scenario B: S-Corp with $130,000 Reasonable Salary

Salary: $130,000. Payroll taxes on this portion: approximately $19,890. Distribution: $220,000. Payroll taxes on this portion: $0.

The difference: roughly $18,000-$20,000 per year in tax savings at $350K net income.

At $500K net income, the savings grow to $25,000+. At $200K, it's closer to $10,000-$12,000. Below $80K or so, the savings may not justify the additional costs of running payroll.

The Breakeven: When Does It Make Sense?

Electing S-Corp status isn't free. It adds costs:

• Payroll processing: $50-$150/month depending on complexity
• Additional tax return: Form 1120-S adds $1,500-$3,500/year in preparation costs
• California franchise tax: $800 minimum plus 1.5% tax on net income
• Bookkeeping requirements: Cleaner books needed — payroll transactions, distribution tracking against stock basis

Total additional cost: $4,000-$8,000 per year. That means you need at least $10,000 in self-employment tax savings to make it worthwhile — which generally kicks in around $70-80K of net income.

Below that threshold, the complexity and cost don't justify the savings. Above it, every year you wait is money you're leaving on the table.

The "Reasonable Salary" Question

This is where I see the most anxiety — and the most mistakes.

The IRS requires that S-Corp owner-employees pay themselves a "reasonable salary" before taking distributions. They don't define a specific number, but they look at: the nature and extent of your services, your training and experience, comparable salaries in similar businesses, and the time you spend working in the business.

For a trade contractor who is the primary estimator, project manager, and client-facing person in a $5M company, "reasonable" is not $40,000. The IRS will look at that sideways. It's also probably not $250,000 if the business nets $350K — that would leave almost nothing as a distribution.

How I Approach It

I pull wage data from the Bureau of Labor Statistics for the specific trade and geographic area. I look at what a non-owner doing the same work would earn. I factor in the owner's specific role — are they swinging a hammer, managing crews, doing estimates, running the office, or all of the above?

For most contractor-owners I work with in Southern California, a reasonable salary lands in the $90,000-$160,000 range depending on the trade, the role, and the company size. That number needs to be documented and defensible. Not aggressive, not conservative — reasonable.

If the IRS reclassifies your distributions as salary, you'll owe back payroll taxes plus penalties and interest. I've seen it happen to contractors who set their salary at $30K while netting $400K. Don't be that person.

When to File the Election

The S-Corp election is made on Form 2553. For a new entity, you have 75 days from formation. For an existing LLC that wants to elect S-Corp treatment, you file by March 15 for the election to be effective for that calendar year.

Miss the deadline? There's late election relief available in many cases, but it adds complexity and uncertainty. If you're reading this and thinking "I should have done this years ago," the answer is: do it now for next year, and talk to your tax advisor about whether late relief is possible for the current year.

One timing consideration specific to contractors: if your income is highly seasonal or project-dependent, you don't have to pay yourself the same amount every month. You can pay quarterly, or even annually. I have clients who take a large salary payment in December once they know their full-year income. The IRS cares that the salary is reasonable and that payroll taxes are paid — the frequency is flexible.

LLC vs. S-Corp vs. LLC Electing S-Corp

I get this question weekly. Here's the simple version:

Sole Proprietor / Single-Member LLC (no election): All net income is self-employment income. Simple, but expensive at higher income levels.

S-Corporation (formed as a corporation, elected S status): Salary + distributions split. Good for single-owner or specific investor situations, but S-Corps have restrictions — no foreign owners, limited to 100 shareholders, one class of stock.

LLC electing S-Corp treatment (Form 2553): You get the liability protection and flexibility of an LLC with the tax treatment of an S-Corp. This is what most contractors should be doing. You keep the LLC operating agreement, the flexible membership structure, and you get the payroll tax savings.

The LLC-electing-S-Corp is the most common structure I set up for contractor clients. Best of both worlds for most situations.

The Partnership Angle

If you're in business with a partner — a brother, a friend from the trades, a former coworker — the structure matters even more.

Two partners in a standard LLC are treated as a partnership. Both partners pay self-employment tax on their share of income. That's two people getting hit with the 15.3%.

The better approach: each partner forms their own S-Corp. Each S-Corp owns a percentage of the operating LLC. Income flows to the S-Corps, each partner takes a reasonable salary from their S-Corp, and the rest comes out as distributions.

More paperwork upfront. But for two partners splitting $500K in net income, the combined tax savings can easily exceed $40,000 per year. That's worth the extra complexity.

California-Specific Considerations

Since most of my clients are in California, a few state-level notes:

California imposes a 1.5% tax on S-Corp net income (minimum $800). The state also charges the LLC annual fee based on total income — $900 at $250K-$500K, $2,500 at $500K-$1M, scaling up from there. These fees apply regardless of entity type, so the comparison isn't always straightforward.

California also doesn't fully recognize the S-Corp election the way the federal government does. Your S-Corp still pays the 1.5% entity-level tax to the Franchise Tax Board. Some practitioners recommend structuring around this, but the federal savings almost always dwarf the California-specific costs.

The key is to model it for your specific situation. I build a side-by-side comparison for every client considering the election — current structure vs. S-Corp, federal and state combined, including the added costs of payroll and preparation. If the math doesn't work, I'll tell you. If it does, we implement it.

The Bottom Line

If you're a trade contractor netting over $80K and you haven't elected S-Corp status, you owe it to yourself to run the numbers. Not a back-of-the-envelope guess — an actual comparison using your real income, your specific trade, and your state tax situation.

The savings are real. The implementation is straightforward. And every year you don't do it is a year you're paying self-employment tax you don't have to.