The question "should I be an LLC or an S corp?" is asked as if it were a choice between two doors. It is closer to being asked whether you would like a car or an automatic transmission.
What an LLC actually is
A limited liability company is created under state law. In New Jersey, that means a filing with the Division of Revenue and Enterprise Services. What it gives you is a separate legal person that owns the business, signs the contracts and, if maintained properly, keeps business liabilities from automatically becoming personal ones.
What an LLC does not do is determine how you are taxed. By default:
- A single-member LLC is disregarded — profit is reported on the owner's personal return
- A multi-member LLC is treated as a partnership — profit flows through to the members
- Either can elect to be taxed as a corporation instead
In all of the default cases, the company itself generally does not pay federal income tax. The owners do.
What an S corporation actually is
An S corporation is a tax status, granted by the IRS when an eligible business files the election. It is not something you form at the state office. Profit still flows through to the owners rather than being taxed at the company level, so on that dimension nothing changes.
What changes is how an owner who works in the business gets paid.
The part everyone is actually asking about
In a default LLC, the owner's share of profit is generally subject to self-employment tax. In an S corporation, an owner who works in the business must be paid reasonable compensation as a W-2 employee. Payroll taxes apply to that salary. Remaining profit is distributed differently.
That is the mechanism behind every S corp pitch you have heard. It is real. It is also frequently oversold, because it comes with conditions.
| Item | Default LLC | With S corp election |
|---|---|---|
| What it is | State legal entity | Federal tax status |
| Who is taxed | Owners, on the profit | Owners, on salary and profit |
| Owner pay | Owner draws | W-2 salary plus distributions |
| Payroll required | Not for the owner | Yes, for working owners |
| Extra filings | Fewer | Corporate return and payroll filings |
Reasonable compensation is not optional
The salary an owner-employee takes has to be reasonable for the work performed. Paying yourself an implausibly small salary to shrink payroll tax is a well-known position, and it is examined. "Reasonable" depends on your role, your industry, hours, and what someone else doing that job would be paid.
This is the single most important thing to get right, and it is not a number to guess at.
What the election costs you
An S corporation is more administration than a default LLC. You are running payroll, which means payroll filings, and you are filing a separate corporate tax return. There is a real annual cost in both fees and attention.
So the honest test is arithmetic: does the change in tax treatment exceed the cost of the extra compliance, reliably, at the profit level you actually expect? Below a certain profit, the answer is often no. There is no universal threshold, despite what you will read.
Who is eligible
Not every business can elect S corporation status. The requirements include:
- A domestic entity
- A limited number of shareholders
- Only allowable shareholder types — generally individuals, certain trusts and estates
- No nonresident alien shareholders
- Only one class of stock, meaning distributions follow ownership proportionally
That last point matters more than it sounds. If partners want to split profits differently from ownership percentages, the single-class-of-stock requirement gets in the way. A partnership-taxed LLC is more flexible on that specific point.
The New Jersey wrinkle
New Jersey used to require a separate state-level S corporation election in addition to the federal one, and businesses got caught out by it regularly. New Jersey has since changed this, so that a federal S corporation election is generally recognized for New Jersey purposes as well, with a mechanism for a business to opt out.
New Jersey also has an elective pass-through entity tax that can matter for owners of pass-through businesses. Whether it helps depends on the specifics. Both of these are worth confirming for your current year rather than assuming, because this is exactly the area where rules have moved recently.
How to decide
Ask these in order:
- Is the business profitable at a level that is stable, not a single good year?
- Would a reasonable salary for the work still leave meaningful profit above it?
- Are you willing to run real payroll, every cycle, permanently?
- Do the ownership arrangements fit the eligibility rules?
- Does the projected benefit clearly exceed the added compliance cost?
If the answer to all five is yes, the election is worth modelling properly. If any answer is no, the default treatment is usually the better place to stay for now — and it is a decision you can revisit as the business changes.