Texas LLC vs. S-Corp — Understanding the Tax Election

This is one of the most misunderstood comparisons in business formation. An S-Corp is NOT a separate business entity type — it is a tax election that an LLC (or corporation) can make with the IRS. You do not choose between an LLC and an S-Corp; you form an LLC and then optionally elect S-Corp tax treatment. For all comparisons, see our comparisons hub.

The Fundamental Distinction

How the S-Corp Election Saves Money (Self-Employment Tax)

Without S-Corp (default LLC): All net business profit is subject to self-employment tax: 12.4% Social Security (up to $168,600 in 2024) + 2.9% Medicare = 15.3%.

With S-Corp election: You split income into two categories:

1. W-2 salary (must be "reasonable") — subject to payroll taxes (equivalent to self-employment tax)
2. Distributions (remaining profit) — NOT subject to payroll/self-employment tax

Texas Example — LLC earning $150,000 net profit:

When S-Corp Makes Sense for Texas LLC Owners

Good candidates (annual net profit > $60,000-$80,000):

• Solo consultant earning $100K+ with few expenses
• Established freelancer with consistent high income
• Professional services firm (medical, legal, tech) with predictable revenue
• E-commerce business with strong margins

Poor candidates:

• Net profit under $40,000 — savings do not offset payroll/CPA costs
• New/inconsistent businesses — hard to predict salary vs. distribution split
• Real estate rental LLCs — passive rental income already exempt from SE tax
• Businesses planning to reinvest all profit (no distributions to shelter)
• Multi-member LLCs with complex allocations — S-corp rules are stricter than partnership rules

Texas-Specific Considerations

No state income tax savings: In states like California or New York, the S-Corp election can save both federal SE tax AND state income tax. In Texas, you only get the federal SE tax savings — there is no state-level benefit because there is no state income tax to optimize.

Franchise tax unchanged: The S-Corp election does NOT affect your Texas Franchise Tax. Your LLC still owes franchise tax based on total revenue (if above $2.47M threshold). The election only affects federal self-employment and income tax.

Simplicity advantage: Because Texas has no state income tax return, running an S-Corp in Texas is simpler than in income-tax states. You file Form 1120-S federally and the franchise tax report with the Comptroller — that is it. No state income tax return to prepare.

How to Make the Election

1. Form your LLC first — Certificate of Formation (Form 205) with the Texas SOS
2. File Form 2553 with the IRS — due by March 15 of the tax year you want it to take effect (or within 75 days of formation)
3. Set up payroll — you must pay yourself a reasonable W-2 salary through proper payroll (withholding, quarterly deposits, W-2 at year-end)
4. File Form 1120-S annually — due March 15 (or September 15 with extension)

FAQ

Is it too late to elect S-Corp for this year?

The deadline is March 15 of the current tax year. If you miss it, late election relief is available if you have reasonable cause and file within 3 years and 75 days of the effective date. File Form 2553 with a statement explaining why it was late.

What is "reasonable compensation"?

The IRS requires S-Corp owner-employees to pay themselves a salary comparable to what they would pay someone else for the same work. Factors: industry norms, geographic area (Texas salaries differ from NYC), experience level, and hours worked. If the IRS considers your salary unreasonably low, they can reclassify distributions as wages and assess back payroll taxes plus penalties.

Can I revoke the S-Corp election?

Yes, effective for the following tax year. File a statement of revocation signed by shareholders holding more than 50% of shares. After revocation, you return to default LLC tax treatment. You cannot elect S-Corp again for 5 years without IRS permission.

Do I need both an LLC and an S-Corp?

No. You have one entity — the LLC. "S-Corp" is just the tax treatment you elected for it. You do not form a separate entity. One LLC, one Certificate of Formation, one state filing — just a different box checked on IRS forms.