The tax mechanism behind this is payroll tax. A sole proprietor or an LLC taxed as a disregarded entity pays self-employment tax, meaning Social Security and Medicare tax, on 100% of net business income. An S corp splits that income into a W-2 salary and a distribution, and only the salary portion owes Social Security and Medicare tax. The election itself is a single form, IRS Form 2553, but it has to be filed within a specific window after the LLC is formed. Miss that window and the election doesn't take effect until the following tax year.

The salary number is where most of the real work is. The IRS requires S corp owners to pay themselves a 'reasonable' salary before taking any distribution, and reasonable isn't a number you pick, it's a number calculated from comparable pay data for the work actually being performed. Set it too low and the IRS can recharacterize distributions as wages, along with back payroll tax and penalties. Set it too high and you're paying payroll tax on income that could have stayed as a lower-taxed distribution instead. The salary also drives how much you can contribute to a Solo 401(k), since the employee deferral and part of the employer contribution are both calculated off W-2 wages, not total business income.

Once the salary is set, a Solo 401(k) is usually the highest-leverage move available. For 2026, combined employee and employer contributions can reach up to $72,000, sheltering a meaningful amount of income from tax at the top of the household's bracket. That number moves every year with both the contribution limits and the owner's salary, so it has to be recalculated annually rather than set once and left alone.

Making the election also creates real administrative obligations. Payroll has to run through an actual payroll provider such as Gusto or ADP, with withholding and quarterly payroll tax filings, not an owner writing themselves a check. On the deduction side, an S corp opens up legitimate write-offs for business use of a vehicle, a home office, a phone or computer used for the business, and wages paid to a child for actual work performed. All of these are real deductions when documented properly, and all of them are audit exposure when they aren't.

None of this happens in isolation. The salary, the retirement contribution, and the deductions all interact with the rest of the household's tax return, including a spouse's W-2 income, existing retirement accounts, the household's tax bracket, and whether a backdoor Roth contribution still works once other IRA balances are in the picture. A salary and retirement number that look right for the business alone can still leave money on the table at the household level.

If you've just been offered a 1099 role, or your LLC or side business has cleared somewhere in the $80,000 to $100,000 range in net income, the S corp election is worth modeling before you assume it's the right move, not after. Below that range, the payroll and filing costs of running an S corp typically cost more than the tax savings, and staying a sole proprietor or a simple LLC is usually the better call.

Most people who set this up on their own, or with a CPA seen once a year at filing time, get the election filed and stop there. The reasonable salary gets set once, sometimes just guessed at, and nobody comes back the following year to recalculate it as income changes, adjust the Solo 401(k) contribution, or check whether the deductions being taken are actually defensible. The complexity of running an S corp shows up whether or not the tax savings do.

This is also a coordination problem more than a one-time filing. Most financial advisors don't touch entity structure or reasonable salary calculations and will point you to a CPA. Most CPAs seen once a year don't model the salary against retirement contribution targets or the rest of the household's tax bracket. Getting the full benefit usually requires tracking the entity, the salary, the retirement plan, and the household tax picture as one coordinated decision instead of three separate conversations.

• Filing the S corp election and never setting or recalculating a defensible reasonable salary, which caps both retirement contributions and audit protection.
• Running payroll off a spreadsheet instead of an actual payroll provider, which creates withholding and quarterly filing exposure.
• Treating the salary and Solo 401(k) contribution as a one-time decision instead of rerunning the math every year as income changes.
• Taking deductions for a vehicle, home office, or a child's wages without documentation to support them if the return is ever examined.
• Electing S corp status well below the roughly $80,000 income threshold where the administrative cost outweighs the tax savings.