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Lower your self-employment tax bill by switching to an S corporation

If you’re a small business owner running a sole proprietorship or partnership, you’ve probably noticed how much self-employment (SE) tax can eat into your income. The good news? There may be a way to lower that bill — by switching your business to an S corporation (S corp).

At Padgett, we work with many business owners who face this same challenge every year. Understanding how your business structure affects your taxes can make a real difference — and an S corp might be the key to keeping more of what you earn.

Understanding self-employment tax

When you run your business as a sole proprietor or a partner in a partnership, the income you earn is typically subject to self-employment tax. The same goes for:

• Single-member LLCs (treated as sole proprietorships), and

• Multi-member LLCs (treated as partnerships).

In 2025, self-employment tax totals 15.3% on the first $176,100 of your net business income.
That breaks down to:

• 12.4% for Social Security, and

• 2.9% for Medicare.

Once your income goes above $176,100, the Social Security portion stops, but the 2.9% Medicare tax continues — and once your income passes certain thresholds ($200,000 for single filers and $250,000 for married couples filing jointly), an extra 0.9% Medicare tax kicks in.

That means higher-earning business owners can face a total of 3.8% in Medicare tax on part of their income.

How an S corporation can help

One potential way to reduce your self-employment tax is by converting your business into an S corporation.

Here’s how it works:

1. You pay yourself a reasonable salary as an employee of the S corp.

2. You take any remaining profits as distributions.

Those distributions aren’t subject to self-employment tax, unlike your salary. Only your wages are.

This setup can significantly reduce how much you pay in federal employment taxes — especially compared to being taxed as a sole proprietorship, partnership, or LLC.

Your Padgett advisor can help you run the numbers and see how much you could save with this kind of structure.

Important things to keep in mind

This strategy can be very effective, but it’s not right for everyone. Here are some things to consider before making the switch:

• Your salary must be “reasonable.”
  • You can’t simply pay yourself a token amount to avoid taxes. The IRS expects you to pay yourself a fair salary based on what someone else would earn doing your job. If the IRS believes your pay is too low, they can reclassify part of your distributions as wages and charge back taxes, penalties, and interest. Your Padgett advisor can help you determine what a reasonable salary looks like for your industry and role.

• Lower salaries may affect retirement contributions.
  • If your S corp offers a SEP or profit-sharing plan, your maximum contribution is based on your salary (typically up to 25%). A smaller salary means smaller potential contributions. However, if your business uses a 401(k) plan, you can still make generous contributions even with a modest salary.

• Expect more paperwork and rules.
  • Running an S corp means extra administrative steps, such as:
    • Filing a separate federal (and possibly state) tax return
    • Keeping corporate records and minutes
    • Tracking any transactions between you and the corporation carefully, since these can have tax implications

The Padgett team can help you stay compliant and manage these extra details so you can focus on running your business.

How to make the switch

If you decide to move forward, here’s what it looks like in practice:

• For sole proprietors or partnerships:
  You’ll need to form a corporation under your state’s laws, transfer your business assets into it, and then file an S corporation election (Form 2553) with the IRS by March 15 if you want it to take effect for that year.

• For LLC owners:
  You may not need to legally incorporate. The IRS allows eligible single-member or multi-member LLCs to elect S corporation status by filing Form 2553 as well — again, by March 15 to apply for that year.

Is an S corp right for you?

Switching to an S corp can be a smart tax move, but it’s not a one-size-fits-all solution. The right choice depends on your income, goals, and how you operate your business.

Before making any changes, reach out to your local Padgett office. We’ll help you:

• Calculate your potential savings,

• Determine a reasonable salary, and

• Make sure you stay compliant with both IRS and state rules.

With the right structure in place, your business can work more efficiently — and you can keep more of what you’ve earned.

The post Lower your self-employment tax bill by switching to an S corporation appeared first on Padgett.