How Schedule C works

A sole proprietor or single-member LLC owner reports business income and expenses on Schedule C, which flows to their personal Form 1040. The net profit is subject to both income tax and self-employment tax. Self-employment tax covers Social Security and Medicare at a combined rate of 15.3% on income up to the Social Security wage base, with 2.9% continuing above that threshold.

The structure is simple. There is no separate business return, no payroll requirement, and no corporate formalities. The owner files one return and pays taxes once.

How an S-Corporation works

An S-Corporation is a separate legal entity that files its own tax return (Form 1120-S). The corporation's income and losses flow through to the owner's personal return on Schedule K-1, similar in concept to a partnership. The key difference from Schedule C is how the owner is compensated.

An S-Corporation owner who works in the business must pay themselves a reasonable salary. That salary is subject to payroll taxes — the employer and employee portions of Social Security and Medicare. Profit above the salary can be distributed to the owner as a distribution, which is generally not subject to self-employment tax.

The potential tax benefit

If a business generates $200,000 in net profit and the owner pays themselves a reasonable salary of $80,000, the remaining $120,000 in distributions is not subject to the 15.3% self-employment tax. The potential savings on that $120,000 can be meaningful — but only if the income level justifies the additional costs.

What the S-Corporation actually costs

• Payroll. You must run payroll for yourself, withhold taxes, make payroll tax deposits, and file quarterly and annual payroll returns (Forms 941, 940, W-2, W-3). This typically requires payroll software or a payroll service.
• Separate corporate tax return. Form 1120-S is a more complex return than Schedule C. CPA preparation fees for an S-Corp return are generally higher than for a Schedule C return.
• New York State S-Corp tax. New York imposes a separate tax on S-Corporations — the fixed dollar minimum tax and potentially the corporate franchise tax — in addition to the owner's personal income tax on the flow-through income. This is a meaningful difference from the federal treatment.
• Corporate formalities. An S-Corporation requires maintaining corporate records, holding annual meetings (even if informal), and keeping the corporate structure in good standing.
• Reasonable compensation scrutiny. The IRS pays attention to S-Corporation owner salaries. Paying yourself an unreasonably low salary to maximize distributions is a known audit trigger.

When the S-Corp election tends to make sense

The S-Corporation election generally becomes worth considering when net business profit is high enough that the self-employment tax savings meaningfully exceed the additional compliance costs. The threshold varies by situation, but many CPAs begin the conversation when net profit is consistently above $80,000–$100,000 — and the analysis becomes more compelling at higher income levels.

It is also worth noting that the S-Corp election is not permanent. It can be revoked, but doing so has its own rules and timing requirements.

Common mistakes

• Electing S-Corp status at low income levels where the compliance costs exceed the tax savings.
• Paying an unreasonably low salary to maximize distributions — a known IRS audit concern.
• Not accounting for New York's separate S-Corp tax when evaluating the benefit.
• Assuming the S-Corp election is a one-time decision with no ongoing administrative requirements.
• Making the election without setting up payroll, which creates compliance problems from day one.