It isn't really one or the other. An LLC is a legal entity you form with the state. An S corporation is a federal tax election, and an LLC can make it. By default, the IRS taxes a one-owner LLC like a sole proprietor and a multi-owner LLC like a partnership, so the owners pay 15.3% self-employment tax on their share of the profit. With the S election, owners who work in the business go on payroll at a reasonable salary, and the profit above it is paid out as distributions, which aren't wages. Whether that saves money depends on how steady your profit is and what it costs to run payroll and file the extra returns.
"Should I be an S corp?" is one of the first questions we hear from contractors whose business has started to make real money. It's the right question, asked the wrong way, and the answer changes as the company grows.
An LLC and an S corp aren't the same kind of thing
An LLC is created under Georgia law when you file with the Secretary of State. It's about ownership and liability. An S corporation is a status you choose with the IRS. It's about how the profit is taxed. That's why you can be an LLC that's taxed as an S corporation, and many contractors are.
So the real decision isn't "LLC or S corp." It's "how do I want my LLC taxed?" If you're still setting the company up, we covered the state steps in Spanish in cómo abrir una LLC en Georgia para construcción.
How the IRS taxes an LLC if you do nothing
According to the IRS, an LLC with one member is treated as disregarded from its owner, and an LLC with two or more members is classified as a partnership. Either way, the company's profit flows to the owners' personal returns.
The part that stings is self-employment tax. The IRS self-employment tax rate is 15.3%: 12.4% for Social Security and 2.9% for Medicare, owed once your net earnings from self-employment reach $400. For an owner of an LLC taxed this way, it applies to their share of the profit whether they take the cash out or leave it in the company to buy equipment.
What the S election changes
An S corporation passes its income, losses, deductions and credits through to its shareholders, who report them on their personal returns. That part looks a lot like an LLC. The difference is how the owner gets paid.
An owner who works in an S corporation is an employee. The IRS says an S corporation must pay reasonable compensation to a shareholder-employee before non-wage distributions can be made. That salary goes through payroll with Social Security and Medicare withheld and matched, just like your crew's. Profit paid out above that salary as distributions isn't wages, so payroll taxes don't apply to it. That's where the potential saving comes from.
The catch is the word "reasonable." The IRS has the authority to reclassify payments to shareholders as wages, and it looks at things like your training and experience, your duties, the time you put in, and what comparable businesses pay for similar work. An owner who runs every job and takes a token salary is exactly the case the IRS looks for. We covered how to set that number in how construction owners should pay themselves.
What an S corp costs to run
The election isn't free. Before it can save you anything, it has to pay for:
Payroll for the owners. Payroll processing, quarterly payroll returns and W-2s, even if you're the only employee in the office.
A separate business return. The S corporation files its own federal return, and in Georgia it files Form 600S. Each owner then gets a K-1 for their personal return.
Rules about who can own it. The IRS limits an S corporation to 100 shareholders and one class of stock, and the shareholders generally have to be individuals, certain trusts or estates, not partnerships, corporations or nonresident aliens. That matters if you plan to bring in a partner through another company, or want to give someone a bigger share of the profit than of the ownership. An LLC taxed as a partnership is more flexible on both.
The construction problem: tax on profit you didn't take out
This one catches contractors in both structures. Whether you're an LLC taxed as a partnership or an S corporation, the profit lands on your personal return in the year the company earns it, not when you take the money out.
Growing contractors usually leave profit in the company. Your surety wants to see working capital and equity, and your bonding capacity grows with them. So a good year can leave you owing personal tax on profit that's sitting in the business as retainage, receivables and equipment. Plan the cash for that tax before the year ends, whichever structure you choose. It's also why the books behind those numbers need to be the kind your surety and your bank will trust.
What doesn't change: your liability
The S election is a tax decision. It doesn't add or remove liability protection, which comes from the entity you formed and how you run it: separate bank accounts, contracts signed in the company's name, and no mixing of business and personal money. And whatever the structure, expect your surety to ask the owners for a personal indemnity agreement. For questions about liability, talk to a business attorney.
When the S election usually makes sense
There's no single profit number where it switches on. It tends to make sense when:
Your profit is steady. The company makes money every year, not just in a good one, and the profit is clearly more than a reasonable salary for the work you do.
You can run payroll properly. Owner salaries on a regular schedule, not one check in December.
Your ownership is simple. The owners are individuals, and profit is split in the same proportion as ownership.
It usually doesn't make sense yet when profit swings between big years and losses, when a reasonable salary would take most of the profit anyway, or when you're about to bring in a partner on special terms.
Timing the election
The election is made on Form 2553. According to the Form 2553 instructions, it has to be filed no more than 2 months and 15 days after the start of the tax year it's meant to cover, or at any time during the year before. An eligible entity that meets the tests in the instructions is treated as a corporation from the effective date and doesn't need to file Form 8832 separately. A late election generally takes effect the following year, though relief may be available if there was reasonable cause.
One Georgia detail. If any owner lives outside Georgia, the Georgia Department of Revenue requires each nonresident shareholder to sign a consent agreement, Form 600 S-CA, agreeing to pay Georgia tax on their share. Without it, Georgia won't recognize the S election.
What to check before you decide
One: pull your net profit for the last two or three years and see how steady it really is. Two: write down what you'd have to pay someone else to do your job, which is the starting point for a reasonable salary. Three: price the extra payroll and return preparation. Four: compare the payroll tax you'd save on distributions against that cost. Five: if the numbers work, file Form 2553 on time for the year you want it to start.
Running these numbers for your company, and setting up owner payroll if the election makes sense, is part of our tax planning for contractors in Atlanta. The election is also one of several ways to lower your tax bill; the others are in what a contractor can deduct.
Sources
IRS, Limited liability company (LLC) · IRS, S corporations · IRS, S corporation compensation and medical insurance issues · IRS, Self-employment tax · IRS, Instructions for Form 2553 · Georgia Department of Revenue, S corporations FAQ