“Should I be an LLC or an S corp?” is one of the most common questions new Ohio business owners ask. It sounds like a choice between two kinds of company, but it isn’t. An LLC is a type of legal entity you form under state law. An S corporation is a federal tax status that an eligible business can elect. That means many businesses are both: an Ohio LLC, for legal purposes, that is taxed as an S corp. The real question is whether, and when, that election makes sense for your company.
The LLC: your legal structure
An Ohio limited liability company separates the business from its owners. Done properly, it generally helps keep business debts and claims away from your personal assets. It also gives owners flexibility, through an operating agreement, in deciding how the company is managed and how decisions get made.
Forming an LLC doesn’t by itself decide how the company is taxed. Under the IRS’s default rules:
- A single-member LLC is generally disregarded for income tax purposes, so its results are reported on the owner’s return.
- An LLC with two or more members is generally treated as a partnership and files Form 1065.
In both cases, the income passes through to the owners. Active owners generally pay self-employment tax on their share of the earnings, whether or not they take the cash out of the business.
The S corp: a tax election
An S election changes how the business is taxed, not what it is under Ohio law. An LLC that qualifies can elect S status by filing IRS Form 2553, then files Form 1120-S each year and gives its owners Schedule K-1s. Income still generally passes through to the owners rather than being taxed at the company level.
Who qualifies
To be eligible, the business must meet several tests, including:
- No more than 100 shareholders (spouses and certain family members can count as one)
- Owners who are individuals, estates, certain trusts or certain exempt organizations, so another LLC or corporation generally can’t be an owner
- No nonresident alien shareholders
- Only one class of stock, although differences in voting rights are allowed
- Written consent from every shareholder
The filing deadline
Form 2553 is generally due no more than two months and 15 days after the start of the tax year the election should take effect, or at any time during the preceding tax year. For a calendar-year business wanting S status for the whole year, that usually means mid-March. If you are thinking about an election for next year, the end of this year is a good time to run the numbers.
Why owners consider the election: self-employment tax
The main draw is payroll tax. The self-employment tax rate is 15.3%: 12.4% for Social Security, on earnings up to a wage base of $184,500 for 2026, and 2.9% for Medicare. An LLC owner taxed as a sole proprietor or partner generally pays this on their net earnings from the business.
An S corp owner who works in the business is an employee. The company pays the owner a salary subject to Social Security and Medicare taxes, and remaining profit can be taken as distributions, which aren’t subject to those taxes.
Here is a simplified example. Suppose a single-owner business earns $120,000 in profit before any owner pay. As a default LLC, the owner’s self-employment tax would be roughly $17,000. If the business were an S corp paying that owner a $70,000 salary, the combined employer and employee Social Security and Medicare taxes on the salary would be roughly $10,700. That’s a difference of about $6,000 before any added costs. The example is only an illustration. The numbers ignore unemployment taxes and other items, and the right salary depends on the facts.
The catch: reasonable compensation
The savings come with a firm limit. An S corp must pay an owner who works in the business a reasonable salary before taking distributions. The IRS treats corporate officers as employees and has successfully challenged arrangements that labeled pay for services as distributions, dividends or loans. In one 2012 federal appeals case, a $24,000 stated salary paid alongside much larger distributions didn’t hold up, and the court looked at whether the payments were truly pay for services.
A reasonable salary depends on what you do, how much time you spend doing it and what comparable work pays. A very low salary designed only to minimize payroll tax invites scrutiny, along with back taxes and penalties.
The costs and trade-offs
An S election isn’t free, and it can make less sense than it first appears. Before electing, weigh:
- Payroll and compliance. You’ll need to run payroll, make deposits, file employment tax returns and file a separate business return, often with professional help.
- Less flexibility in splitting profits. The one-class-of-stock rule generally requires distributions in proportion to ownership. An LLC taxed as a partnership can often use more customized economic arrangements, which matters for businesses with investors or unequal partners.
- Limits on future owners. The shareholder rules can get in the way if you later want an entity or a nonresident alien investor to own part of the company.
- Effect on the federal QBI deduction. The 20% deduction for qualified business income under Section 199A is now permanent, but reasonable compensation paid to an S corp owner isn’t qualified business income. Shifting income to salary can reduce the deduction, even while W-2 wages may help higher earners meet its limits.
- Lower reported earnings. A smaller salary means smaller earnings reported for Social Security purposes, which can affect future benefits.
- Real estate holdings. Moving appreciated property out of an S corp can create tax problems, so rental property owners should get advice before electing.
Ohio considerations
Ohio’s Business Income Deduction lets individuals deduct up to $250,000 of eligible business income ($125,000 if married filing separately), and business income above that is taxed at a flat 3%. Ohio’s guidance also says compensation or guaranteed payments a pass-through entity pays to an investor holding at least a 20% interest are reclassified as business income. Those rules may change the state tax picture, so ask your tax adviser to run them alongside the federal numbers.
When the election tends to make sense
There’s no universal income figure at which S status becomes the right answer. In general, it’s worth a serious look when an active owner’s profits consistently exceed a reasonable salary for their work by enough to outweigh the added costs. It’s often less attractive when a business is new, profits are low or unpredictable, or the owners want flexible profit-sharing or plan to bring in outside investors. Many owners start as a default LLC and revisit the question as the business grows.
Getting started
- Gather your last year or two of profit figures, or a realistic projection for a new company.
- Research what it would cost to hire someone else to do your role.
- Have your CPA compare your total tax and compliance costs both ways, including the QBI deduction and Ohio’s rules.
- Review your operating agreement, since S status can require changes to provisions on distributions, allocations and who may become an owner.
- If you decide to elect, calendar the Form 2553 deadline and set up payroll before the first owner payment.
Vincent Esquire helps Ohio entrepreneurs form their companies and put the right governing documents in place, working alongside their tax advisers. Learn more about our business law services or reach out to talk through your plans.
This article is for general informational purposes only and is not legal advice. Reading it does not create an attorney-client relationship. Laws change and every situation is different, so consult an attorney about your specific circumstances. Attorney advertising.
