2026 Entity Choice Checkup: When a Sole Prop Should Switch to an S‑Corp Under the New Rules

If you are a profitable sole proprietor or single‑member LLC, 2026 is the year to re‑test whether staying put still makes tax sense. With the One Big Beautiful Bill Act making the QBI deduction permanent and expensing rules more generous, the S‑corp election can save thousands in self‑employment taxes—but only when your numbers and salary strategy support it.

This guide explains when a move from sole prop to S‑corp is worth exploring, how the 2026 rules affect that decision, and what to watch out for so you do not trade one set of problems for another.

Sole prop vs. S‑corp in 2026: the basics

As a sole proprietor or single‑member LLC, all your net business profit is generally subject to income tax and the full 15.3% self‑employment tax. It is simple and flexible, but as profits grow, the payroll tax hit grows with them.

An S‑corp is still a pass‑through for income tax, but you split your earnings into two buckets:

• Reasonable salary (subject to payroll taxes).
• Distributions (not subject to self‑employment tax, though still subject to income tax).

That split is where most of the potential tax savings come from—but also where the IRS pays close attention.

When an S‑corp starts to make sense

There is no one magic profit number, but many CPAs suggest that S‑corps usually start to pencil out once your consistent net profit crosses a certain threshold.

Common guidelines in 2026:

• Below roughly $60,000 in steady annual profit: the complexity and payroll costs often outweigh the savings.
• Around $60,000–$150,000+ in profit: an S‑corp often produces meaningful self‑employment tax savings if you pay yourself a defensible salary and take the rest as distributions.

If your net profit jumps around from year to year, you may want to wait until you see a stable pattern before making the election.

How 2026 rules and QBI affect the decision

Under the post‑OBBBA rules, the QBI deduction (up to 20% of qualified business income) is now permanent and has more generous thresholds. That matters whether you are a sole prop or an S‑corp, because both structures can qualify as pass‑through entities.

However, salary and QBI interact differently in an S‑corp:

• S‑corp salary is not QBI‑eligible, so higher wages reduce QBI.
• S‑corp distributions are QBI‑eligible, which can increase the amount getting the 20% deduction.

In practice, you are balancing three forces:

• Saving self‑employment tax by shifting profit from wages to distributions.
• Preserving as much QBI‑eligible profit as possible.
• Staying within the IRS’s idea of reasonable compensation for your role and industry.

This trade‑off is why modeling the numbers (ideally with a pro) is crucial before flipping the S‑corp switch.

Reasonable compensation: what the IRS expects

You cannot pay yourself a token salary and call the rest distributions without inviting scrutiny. The IRS expects S‑corp owner‑operators who work in the business to take reasonable compensation as wages for the services they perform.

Factors that go into a reasonable salary analysis:

• Your role and responsibilities (owner‑operator vs. more passive owner).
• Industry norms and what you would pay someone else to do your job.
• Time spent in the business and the business’s overall profitability.

If the IRS decides your salary is unreasonably low, it can reclassify distributions as wages and assess back payroll taxes, penalties, and interest.

Non‑tax trade‑offs: complexity and admin

Even when the math favors an S‑corp, the structure is not free. You will typically add:

• Payroll processing (or software) for your own wages.
• Separate S‑corp tax filings and possibly state‑level filings.
• More formal bookkeeping and documentation around salary decisions and distributions.

If you are not ready for that level of discipline—or you do not have the help to support it—staying a sole prop or standard LLC a little longer may be the better move even at higher income levels.

A quick checklist: should you explore an S‑corp in 2026?

You might be ready for a serious S‑corp conversation if:

• Your business has at least $60,000–$80,000 in consistent annual profit (after expenses).
• You expect that profit level or higher to continue, not just spike for one year.
• You are willing to run legitimate payroll for yourself and keep cleaner books.
• You want to proactively manage self‑employment tax and use 2026’s permanent QBI rules to your advantage.

From there, the next step is to have a tax pro model your current sole prop scenario vs. a 2026 S‑corp scenario so you can see real dollar differences after payroll costs and advisory fees.