Published by AE Tax Advisors Team • 2025-10-01

Sole Proprietor Saves $28,000 Per Year by Electing S-Corp Status

The Client

Derek Washington, a freelance IT consultant in Dallas, Texas, was operating as a sole proprietor earning $210,000 per year in net business income. He had been filing Schedule C for six years and had no employees.

The Problem

As a sole proprietor, Derek was paying self-employment tax (Social Security and Medicare) on his entire $210,000 of net income -- approximately $29,700 per year. His total federal tax burden including income tax exceeded $62,000 annually. He had never been advised that an entity election could reduce his SE tax exposure.

Our Strategy

We helped Derek form an LLC and elect S-Corporation tax treatment by filing Form 2553. We established a reasonable salary of $95,000 per year -- benchmarked against IT consulting industry data for the Dallas market -- and the remaining $115,000 would be distributed as S-Corp distributions not subject to self-employment tax. We also set up a Solo 401(k) to maximize retirement contributions.

The Results

By converting $115,000 from self-employment income to S-Corp distributions, Derek eliminated approximately $17,600 in Social Security and Medicare taxes on that portion. Combined with the Solo 401(k) deduction and QBI deduction optimization, his total annual savings reached $28,000. Over five years, that represents $140,000 in cumulative tax reduction.

Key Takeaway

Sole proprietors earning over $80,000 in net business income should evaluate S-Corp election. The self-employment tax savings on distributions above a reasonable salary can be substantial and compound significantly over time.