Should my consulting LLC elect S corporation status, and what does that do to QBI and my retirement plan?

Greymill AcademyUS6 min readReviewed Oct 202629 primary sourcesUK version

The short answer

For consultants, the S election, the phase-out of the qualified business income (QBI) deduction for service businesses and the retirement plan interact, so the headline payroll tax saving is only the start of the answer.

The takeaway. Model the S election at a salary you can defend, then check what it does to QBI, retirement contributions and state or city tax before filing Form 2553.

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Written for independent consultants, fractional executives and small consulting firms that use employees or subcontractors.

The short version

  1. Pay yourself a salary you can defend.It comes before any distributions. Set it too low and the IRS can treat distributions as wages, with back payroll tax, penalties and interest.
  2. Check what that salary does to your 401(k).The employer share of a solo 401(k) is based on W-2 pay, so a lower salary lowers what you can put away.
  3. Model it with your CPA before Form 2553.Include state or city tax and the qualified business income (QBI) deduction, which phases out for consultants at higher incomes.

The basic case for an S corporation is familiar: a salary through payroll, the rest as distributions without payroll tax. For a consultant three things complicate it. The salary has to be one you can support, consulting is a specified service business for the qualified business income (QBI) deduction, and some states and cities tax S corporations in ways that eat the saving.

The payroll tax saving, worked

Single owner, $180,000 profit, $90,000 salary
Social Security tax on $166,230 of self-employment earnings$20,612.52
Medicare tax$4,820.67
Self-employment tax as a single-member LLC$25,433.19
Payroll tax saving as an S corporation$11,621.19

$25,433.19 minus $13,770 of FICA on the $90,000 salary and $42 of federal unemployment taxIndicative worked example, as of Oct 2026, single filer. The saving is before payroll, state unemployment, return and entity costs, and the $90,000 salary is an assumption that has to be supportable.

The rule

Reasonable compensation comes first

An S corporation owner-employee takes reasonable compensation through payroll before distributions. Watson upheld recharacterization where a CPA took $24,000 of salary and about $200,000 of distributions, so the IRS can reclassify distributions as wages, with back FICA, penalties and interest. As of Oct 2026.

David E. Watson, P.C. v. United States, 668 F.3d 1008 (8th Cir. 2012)

State and city: where the answer changes

  • California: an S corporation pays 1.5% of net income, minimum $800; in the worked example that is $1,246.10 on $83,073. An LLC pays the $800 annual tax and, once its total income derived from or attributable to California reaches $250,000, an LLC fee as well. As of Oct 2026.
  • New York City does not recognize the S election. An S corporation pays the city's GCT at 8.85% of allocated net income, while an LLC or sole proprietor pays the 4% Unincorporated Business Tax, which its credits reduce or eliminate at lower incomes. As of Oct 2026.
  • Pass-through entity tax (PTET): an S corporation or a multi-member LLC can elect to pay state income tax at the entity level, where it is deductible federally and credited to the owners, which gets around the SALT cap (IRS Notice 2020-75). A single-member LLC taxed as a sole proprietor cannot. California's elective tax is 9.3% of qualified net income and runs through 2030; New York's election is due by March 15 each year. As of Oct 2026.

QBI: consulting is a specified service business

The rule

The QBI deduction phases out for consultants

Consulting is a specified service trade or business. For 2026 its QBI deduction phases out for taxable income from $201,750 to $276,750 single and from $403,500 to $553,500 joint. The S election also reduces QBI by the wages you pay yourself. As of Oct 2026.

IRC 199A(d)(2); Treas. Reg. 1.199A-5(b)(2)(vii)

For example, as of Oct 2026, a single filer with $240,000 of taxable income before the deduction, $200,000 of QBI and no W-2 wages or qualified property counts only 49% of that QBI, or $98,000, and the deduction comes to $9,604.

Retirement plans move with the structure

As of Oct 2026, on $180,000 of sole-proprietor profit a SEP allows $33,456.68 and a solo 401(k) allows $57,956.68, including the $24,500 employee deferral. On a $90,000 S corporation salary, a solo 401(k) supports $22,500 employer plus $24,500 employee, or $47,000, because the employer share is based on W-2 pay. The salary you choose also sets your retirement ceiling.

AvoidSetting the S corporation salary as low as you think you can defend, without checking what it does to your solo 401(k).
Do this insteadHaving your CPA model payroll tax, QBI and retirement contributions together at a salary you can support, and reviewing that salary before the first payroll of each year.

As of Oct 2026, in the worked example a $90,000 salary saves $11,621.19 of payroll tax but cuts the most you can put into a solo 401(k) from $57,956.68 to $47,000, and a lower salary cuts it further.

Sales tax on work you bundle with advice

Pure consulting advice is not subject to sales tax in most states, but some states tax work that consultants often bundle with it. As of Oct 2026, Texas taxes data processing and information services on 80% of the charge, New York taxes information services, and Hawaii, New Mexico and South Dakota tax most services. Washington has treated information technology services, custom software and custom website development as retail sales since October 1, 2025, with their removal scheduled for January 1, 2029. Split taxable and non-taxable items on the invoice.

Timing: for the election to apply to a tax year, file Form 2553 during the year before or within 2 months and 15 days of that year's start. Filed later, it generally takes effect the following tax year unless the IRS grants late-election relief (IRC 1362(b); Rev. Proc. 2013-30). As of Oct 2026. Have your CPA or enrolled agent model the election, QBI, retirement contributions, state unemployment, payroll and return costs before you file.

Asked in Greymill

Example question and answer from Tax & Bookkeeping
You
Single-member consulting LLC, $180,000 profit a year, and I file single. Plan is to elect S corp, pay myself $90,000 and keep maxing my solo 401(k). Filing Form 2553 this week. Anything I'm missing?
Tax & Bookkeeping
You're missing your 401(k). The election saves about $11,621 of payroll tax, but cuts your 401(k) ceiling by about $10,957 (As of Oct 2026).

Payroll tax (As of Oct 2026)
As an LLC: $25,433.19 self-employment tax
As an S corp: $13,770 of FICA (payroll tax) on the salary, plus $42 of federal unemployment tax
Saving: $11,621.19, before payroll, state unemployment, return and entity costs

Your 401(k): the employer share is based on W-2 pay, so your maximum falls from $57,956.68 to $47,000 (As of Oct 2026). A lower salary cuts it further.

Also check
Salary: $90,000 has to be supportable, or the IRS can reclassify distributions as wages.
QBI: the salary you pay yourself comes off your qualified business income, the base for your QBI deduction.

Before you file, have your CPA model it all, including state and city tax. Shall I lay these numbers out for that meeting?

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Your question

I run a consulting business in [state], in the US. It is a [single-member LLC / S corporation] with about [amount] of profit, and I file [single / joint]. I [do / do not] work in New York City, and some of my work is [any data, IT or software work you bill]. Model the S election at a salary of [amount] that I could support, including state and city tax, the QBI phase-out for consulting and what each option lets me put into a SEP or solo 401(k), and tell me whether any of my invoices need sales tax.

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Sources

The primary sources behind this lesson, checked Oct 2026.

  1. IRC 1401, 1402(a)(12); SSA 2026 contribution base (LLC or S corporation, worked for 2026)
  2. opinion (LLC or S corporation, worked for 2026)
  3. R&TC 23802 (LLC or S corporation, worked for 2026)
  4. IRC 162(l); Notice 2008-1 (LLC or S corporation, worked for 2026)
  5. IRC 11(b); 1202(e)(3) (LLC or S corporation, worked for 2026)
  6. IRC 199A(d)(2); Treas. Reg. 1.199A-5(b)(2)(vii) (QBI, estimated tax and deductions)
  7. Rev. Proc. 2025-32 s.4.26; IRS SSTB and wage/property-limit overview (QBI, estimated tax and deductions)
  8. IRC 6654(c), (d)(1)(C); IRC 7503 (QBI, estimated tax and deductions)
  9. IRC 6041A, 3406 (QBI, estimated tax and deductions)
  10. Rev. Proc. 2013-13; IRC 280A(c)(1) (QBI, estimated tax and deductions)
  11. IRC 274(a), (n) (QBI, estimated tax and deductions)
  12. 2026 annual additions, elective-deferral and catch-up limits; Notice 2025-67 (Retirement plans for consultants)
  13. 90 FR 44527 employer-specific wage rule; Notice 2025-67 threshold (Retirement plans for consultants)
  14. IRC 401(b)(2) as added by SECURE 2.0 Act of 2022 s.317 (Pub. L. 117-328, Div. T) (Retirement plans for consultants)
  15. filing requirement; 2025 Form 5500-EZ instructions (Retirement plans for consultants)
  16. R&TC 17941, 17942, 23153 (State and local tax: ca, ny and nyc, tx, fl, wa)
  17. Tax Law 658(c)(3); Form IT-204-LL instructions (State and local tax: ca, ny and nyc, tx, fl, wa)
  18. Tax Law 210(1)(d); Form CT-3-S instructions (State and local tax: ca, ny and nyc, tx, fl, wa)
  19. NYC Admin. Code 11-603, 11-503 (State and local tax: ca, ny and nyc, tx, fl, wa)
  20. Tax Code 171.002, 171.006 (State and local tax: ca, ny and nyc, tx, fl, wa)
  21. Tax Code 151.0035, 151.351 (Sales tax on services, sourcing and PTET)
  22. Tax Law 1105(c)(1) (Sales tax on services, sourcing and PTET)
  23. DOR newly taxable services; Ch.238, Laws of 2026 ss.1001 to 1003 and 1202 (Sales tax on services, sourcing and PTET)
  24. 585 U.S. 162 (2018) (Sales tax on services, sourcing and PTET)
  25. California R&TC 25136 market sourcing; New York TSB-M-06(5)I convenience rule (Sales tax on services, sourcing and PTET)
  26. annual election (Sales tax on services, sourcing and PTET)
  27. Instructions for Form 2553, When to file (Who must sign off, and what goes first)
  28. IRC 6072, 6031, 7503 (The us calendar: federal forms, state LLC tax and SAM renewal)
  29. Forms 3522 and 3536 (The us calendar: federal forms, state LLC tax and SAM renewal)

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