S Corp vs Schedule C: The $20K Tax Divide Most Self-Employed Miss in 2025
Picture this: two entrepreneurs earning $150,000 in California. One files taxes as a sole proprietor on Schedule C. The other chooses S Corporation status and takes a structured approach to pay herself. Their end-of-year tax bills? Not even close. If you’re self-employed, a freelancer, or own a solo business, understanding the difference isn’t just technical—it’s about whether you keep or lose five figures to the IRS each year.
Quick Answer: Why S Corp and Schedule C Aren’t Even in the Same Ballpark
For the 2025 tax year, filing on Schedule C means your entire net business income is subject to the self-employment tax and standard income tax. An S Corp, by contrast, splits income between salary (W-2) and distributions, with only salary triggering payroll taxes. This structural shift can easily save $10,000–$20,000 for six-figure earners—when set up and run right.
When comparing S Corp vs Schedule C, think of it as choosing how the IRS views your labor versus your ownership. A Schedule C treats every dollar of net profit as self-employment income under IRC §1402—subject to the full 15.3% FICA rate. An S Corporation, by contrast, allows you to carve out a “reasonable salary” and treat the remainder as passive shareholder profit, bypassing payroll tax on that portion. That’s why proper structuring—not just forming an S Corp—is what drives five-figure savings.
This information is current as of 10/31/2025. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.
Where the $20K Tax Gap Really Comes From: S Corp vs Schedule C Breakdown
Self-employment tax for a Schedule C filer is a brutal 15.3%—combining Social Security and Medicare, it hits every dollar of net profit you report. For a $150,000 income, that means the first $137,700 is subjected to Social Security tax (capped for 2025, per IRS figures), and the rest faces Medicare. Total taxes for Schedule C filers can push 33–38% after federal, state, and self-employment taxes in California.
S Corps play a different game. The IRS allows you to split income between a “reasonable salary” (subject to payroll taxes) and profit distributions (not). Let’s say you set a salary at $60,000 and pay the rest as distributions. Only the $60K is hit with the 15.3% payroll tax. On $90,000 distributed, you skip these taxes. Savings? Typically $12,000–$18,000 a year at this level—and more as you earn more.
The S Corp vs Schedule C decision also impacts how deductions flow and how income is tested for certain credits. Schedule C income counts as self-employment earnings, boosting your Social Security base but also inflating Adjusted Gross Income (AGI). In an S Corp, part of that income shifts to distributions reported on Schedule K-1—not subject to SE tax—and can help you qualify for AGI-sensitive deductions and even reduce QBI phaseouts under §199A. That’s a nuanced but critical play for high earners brushing against the $191,950 (single) or $383,900 (joint) QBI limits in 2025.
For a deeper dive into S Corp strategies, see our complete S Corp tax guide for 2025.
KDA Case Study: 1099 Designer Cuts Tax Bill in Half With S Corp Move
Meet Alex, a freelance graphic designer in Los Angeles. In 2024, Alex ran her $120,000 design business as a sole proprietor using Schedule C. After subtracting $25,000 in business expenses, she paid income tax—and also got hit with $14,535 in self-employment tax ($95,000 x 15.3%). Total federal and CA state taxes: just under $29,000. Frustrated, she turned to KDA before filing for 2025.
We set up an S Corporation for Alex. The new strategy let her draw a $50,000 W-2 salary (subject to payroll taxes) and take the rest as shareholder distributions. Instead of paying payroll taxes on $95,000 of profit, she owed it only on $50,000—saving about $6,885 in SE tax. Total tax savings, after accounting for increased payroll costs and administrative fees: $7,900 in year one. Her investment for the restructure, setup, and compliance? $2,600. First-year ROI: more than 3x—and every dollar saved goes back in her business.
Ready to see how we can help you? Explore more success stories on our case studies page to discover proven strategies that have saved our clients thousands in taxes.
Key Difference #1: How Self-Employment Tax Drains Schedule C Filers
The biggest myth among freelancers and sole proprietors is that self-employment tax is “just part of the deal.” For every $100,000 of net income you report on Schedule C, you’ll pay $15,300 in SE tax before federal and state even start. This is calculated on Schedule C (Form 1040) and summarized on Schedule SE.
- W-2 Employees don’t pay this on side gig income, but their employer covers half their payroll tax; Schedule C filers foot both sides.
- 1099 Contractors pay both employer and employee portions—meaning you owe the full 15.3%.
- LLC Owners default to Schedule C unless they elect S Corp treatment.
Trap: Even if you “reimburse” business costs or use credit cards, the IRS expects SE tax on every net dollar after write-offs. Misreporting or guessing puts you on audit radars fast.
Key Difference #2: The S Corp Salary Rule Most Owners Get Wrong
The IRS wants S Corp owners to pay a “reasonable salary,” not avoid all payroll taxes. There’s no set number, but it must match market rates for your service. The risk? Underpay and the IRS can retroactively reclassify your distributions as wages and hit you with back taxes, penalties, and even a 20% understatement charge (see IRS S Corp guidance).
- For most California professionals (consultants, coaches, designers), $45,000–$80,000 is a defensible salary range for $120K–$200K income.
- Distributions are not subject to SE tax, but you must still pay income tax.
Red Flag Alert: Paying yourself below-market wages (or skipping payroll) almost guarantees an IRS audit in 2025. Document your pay structure with comps, contracts, and pay stubs.
Pro Tip: Use Gusto or QuickBooks payroll to run W-2 payroll for yourself—this keeps you compliant and speeds up year-end reporting.
Why Most Self-Employed Miss the S Corp Advantage
Convenience is costly. About 78% of California solopreneurs stick to Schedule C because it’s “easy”—no formal payroll, no corporate filings, no need for a separate bank account. The price? Overpaying $6,000–$30,000 per year in taxes, plus increased audit exposure (IRS says Schedule C filings are 4x more likely to be audited than S Corps).
- Not knowing about the S Corp election for LLCs or sole proprietors
- Fearing ongoing “corporate” paperwork (most of which is automated in 2025 software)
- Confusing state corporation fees (CA Franchise Tax is mandatory for all entities, even LLCs—see California FTB)
Don’t make fear or laziness your most expensive line item. A temporary learning curve is worth years of compounding savings.
What If You’re Not Ready for an S Corp?
If your net income is under $50,000, or you have big losses from a startup or real estate, staying Schedule C (for now) might make sense. The setup costs, payroll software, and annual filings can outweigh the benefits at low income levels. For anyone grossing $75,000+ a year? Move to S Corp or pay the SE tax penalty.
Can Real Estate Investors or Landlords Use S Corps?
Short answer: No, not for rental income. The S Corp split only works for active business income (not passive Schedule E rental income), but can be valuable for real estate agents or flippers. For more, check our real estate investor tax page.
What’s the Process to Switch from Schedule C to S Corp?
- File IRS Form 2553 to elect S Corporation status (typically by March 15 of the relevant tax year).
- Set up and fund a separate business bank account.
- Choose a payroll system and start W-2 wage payments.
- Keep clear records—split distributions and salary for reporting.
- Consult an advisor to structure “reasonable” comp and avoid under/overpayment issues.
Will This Attract IRS Scrutiny?
S Corps are watched by the IRS, especially new or all-digital LLCs (coaches, consultants, content creators). Keep every payroll stub, distribution register, and board/minutes document—even if you’re sole owner. Don’t “set and forget”; review salary benchmarks yearly.
How to Avoid the Top Mistakes: Audit Triggers, Documentation, State Filing
Three common landmines trip up new S Corp owners in California every year:
- Missing the March 15 deadline for Form 2553—late election means no S Corp for the whole year.
- Failing to process quarterly payroll or remit employment taxes; this draws instant penalty letters.
- Forgetting annual California Franchise Tax, which is due regardless of profit or loss.
Myth Bust: S Corps only save if you actively split distributions and salary—just forming does nothing. Proper documentation (W-2, K-1, corporate minutes, annual meeting logs) is key to airtight audit defense. See IRS S Corporations and Self-Employed Tax Center pages for rule details.
FAQ: S Corp or Schedule C?
- Can I have both? If you have multiple businesses, yes—operate one as a sole prop, another as an S Corp, but never for the same business at once.
- What if I miss the election deadline? File ASAP; some relief may be available for late elections—but don’t count on it.
- Is an LLC automatically an S Corp? No. LLCs default to Schedule C unless they formally elect S Corp status with the IRS.
- How much do S Corp services cost? Most pay $1,500–$2,500/year for compliance and payroll setup—when you’re saving $10K+, it pays for itself.
Book Your Custom Entity Review
If you’re self-employed or run a small business and suspect you’re leaving money on the table with your current tax structure, don’t guess. Our team will review your entity setup and show you the $10,000–$30,000 of annual tax savings you could be missing. Book your consultation with KDA and take home more of what you earn in 2025.
