Self-employment tax — 15.3% covering Social Security and Medicare — applies to net profit from a sole proprietorship, single-member LLC, or a member’s share of partnership income from services. It doesn’t apply to W-2 wages beyond the standard payroll tax withholding, or to S-corp distributions. That distinction is the entire reason entity choice has become one of the biggest levers small business owners have over their real tax bill.
The Math on a Sole Proprietorship or Default LLC
All net profit from a sole proprietorship or a single-member LLC (taxed as a disregarded entity) is subject to the 15.3% self-employment tax — 12.4% for Social Security up to the annual wage base ($184,500 for 2026) and 2.9% for Medicare with no cap, plus an additional 0.9% Medicare surtax above $200,000 single/$250,000 married filing jointly. On $150,000 of net profit, that’s roughly $21,000 in self-employment tax before any income tax is even calculated — and none of it is avoided just because the business operates through an LLC, since a default single-member LLC gets no self-employment tax benefit over an unincorporated sole proprietorship.
How S-Corp Election Actually Changes the Number
Electing S-corp status lets the same $150,000 be split into, say, a $70,000 reasonable salary (subject to the same 15.3% payroll tax, split between employer and employee halves) and an $80,000 distribution that isn’t subject to self-employment or payroll tax at all. That split alone can save more than $12,000 in a single year on this example — but it isn’t free: the S-corp has to actually run payroll (with the administrative cost that involves), file its own return, and the salary figure has to be genuinely defensible as “reasonable” for the work performed, not set artificially low just to minimize tax.
Why the Salary Number Is the Whole Fight
The IRS has no fixed formula for “reasonable compensation” — it looks at what similar businesses pay for similar work, the owner’s actual duties and time commitment, and industry-specific data. Setting the salary too low to maximize the self-employment tax savings is the single most common reason an S-corp gets flagged on audit; setting it defensibly (often using real market-comparable wage data for the specific role and industry) is what actually protects the savings this structure is built around.
Profit Level Is the Real Trigger for Reconsidering Entity Choice
The self-employment tax savings from S-corp election only shows up on profit above the salary paid — so a business with modest, steady profit may not clear the added payroll and compliance cost to make the switch worthwhile, while a business whose profit has grown well past what a reasonable owner salary would be is often leaving real money on the table by staying a sole proprietorship or default LLC. This is the specific number worth re-running every year as profit changes, not a one-time decision made at formation and never revisited.
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Related reading: LLC vs. S-Corp vs. C-Corp and S-Corp Reasonable Compensation.
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