I am not an accountant, but I do have a good understanding of this concept.
It works like this. If you are self employed there is a slef employment tax on all your income of 15%. This essentially goes toward social security and Medicare.
So let's say you make $100k in profit that means it's $15k in self employment tax.
If you instead become and LLC and file as an S-Corp then self employment tax goes away and is replaced with social security and Medicare on "wages" only. The company then pays you a "reasonable wage" of let's say $30k in this case, and then pays the other $70k out to you as "dividends". The $30k is subject to social security and Medicare which comes to a little under 15% with all things considered (~$4500) and the dividends are not.
This creates a rough tax savings of $10,500.
(Talk to your accountant for exact numbers and advice for your situation, this is just the basic concept.)
Here are some more resources on the subject:
Hello, my name is Carlos Quintana and I have worked many years in accounting specializing in tax strategies for entities. This question is very common and very simple to answer, however like any other accounting question the answer might varie according to specifics. Furthermore, a very simple benefit to the election of S-corp would be that you do not pay any self employment tax, which can translate to thousands of dollars being saved. A very important benefit for the entity itself (LLC) would be the easiness to maintain it. There is no requirement to maintain record of your annual minutes to maintain for the shareholder and director meetings. Those is my opinion are 2 of the most beneficial things from a LLC with an S-Corp election.
There are a number of advantages and drawbacks to making an S corporation election, however, most of the time it works in the favor of the owner. In situations where an LLC is owned 100% by an individual, the LLC is a disregarded entity for U.S. tax purposes, which means the LLC does not file its own tax return. The income and expense is reported on Schedule C and attached to the individual owners' Form 1040. All of the earnings are subject to federal income taxes as well as self-employment taxes.
If the owner files an S corporation election via Form 2553, the LLC is now a regarded entity for U.S. tax purposes. The LLC files an annual Form 1120-S and the net income (loss) is passed through to the individual owners' Form 1040. Earnings are subject to federal income taxes, but they are not subject to self-employment taxes. If the 100% owner of the S corporation actively participates in the business, the owner will need to pay themselves a reasonable salary, which will be subject to U.S. federal payroll taxes on the wages. Reasonable compensation issues can be complex with S corporations, so it is best to consult a tax professional when setting your salary.