Setting Up an S-Corp as an Independent Contractor

First published in 2017; rewritten November 2026.

Many independent contractors hear that they should "set up an S-Corp". It can save money, but it is rarely the first step, and it is not a kind of company at all. Here is what it is, when it can make sense, and what it costs to run.

The usual first step

Most contractors start as a sole proprietor: you do the work in your own name, there is nothing to file to begin, and your business income goes on your personal tax return. Many then form a limited liability company (LLC) with their state, which keeps the business separate from their personal finances. An LLC and a corporation are business entities; an S corporation is something else.

What an S corporation is

"S corporation" is a tax election. An eligible corporation or LLC files IRS Form 2553 to be taxed under Subchapter S. To be eligible, a business generally has no more than 100 shareholders, only one class of stock, and owners who are US citizens or residents. The election is due no later than two months and 15 days after the start of the tax year it is meant to cover.

How the taxes work

An S corporation usually pays no federal income tax itself. Its profit passes through to the owners, who report it on their personal returns and pay income tax on it.

The difference is in self-employment tax. As a sole proprietor or a single-member LLC, you pay self-employment tax on all of your net business income. As an S corporation owner who works in the business, you must pay yourself a reasonable salary through payroll, with the usual payroll taxes withheld. Profit above that salary can be taken as distributions, which are not subject to self-employment tax. That gap is where the savings come from.

What it costs

The election adds work and fees: running payroll for yourself, filing a separate business return (Form 1120-S) every year, state fees and filings that vary by state, and careful bookkeeping. The salary also has to be reasonable for the work you do; setting it too low to avoid payroll taxes draws attention from the IRS.

So the election tends to pay off only once your profit is high enough that the self-employment tax you save is larger than what it costs to run payroll and file the extra return. Where that point is depends on your income, your state and your expenses.