Construction Company Entity Structure: LLC vs S-Corp and the QBI Deduction for Contractors

By Yarik Yarosh, CPA ·August 27, 2026 ·Updated September 23, 2026 ·16 min read

Written by Yarik Yarosh, CPA (US & Canada) September 6, 2026 · FL CPA license AC61704 · CPA Ontario

For most contractors whose profit runs well past what they’d have to pay a manager to do their job, the answer is an LLC that elects S-corp tax treatment. The LLC gives you the liability shield. The S election takes the profit above a reasonable salary out of the 15.3% self-employment tax base. Construction isn’t a specified service business, so the 20% QBI deduction under IRC 199A stays available at any income level, and the same salary decision that saves payroll tax also feeds the W-2 wage limit on that deduction. Start by checking whether your net profit sits well above that salary year after year.

✓Key takeaway

An LLC by itself changes nothing on the tax side; it’s the S-corp election that splits profit into a salary that carries payroll tax and distributions that don’t. Construction isn’t a specified service trade or business, so the 20% QBI deduction never phases out for a contractor, but above the income threshold it’s capped by W-2 wages and equipment basis, which means a salary set too low can cost more in lost QBI than it saves in payroll tax. The One Big Beautiful Bill Act made the QBI deduction permanent and widened the phase-in range from 2026.

Does an LLC lower a contractor’s taxes on its own?

No. A single-member LLC is a disregarded entity for federal tax, so its profit lands on Schedule C exactly the way a sole proprietor’s does, and every dollar of it is self-employment income. The LLC is still worth having in construction, where jobsite injuries and contract disputes are routine, because it separates business debts from your house and savings. It just doesn’t change the tax bill until you pair it with an S-corp election. The self-employment tax on a sole proprietor or disregarded LLC works like this.

Net earnings from self-employment are 92.35% of net profit (Schedule SE line 4a: “multiply line 3 by 92.35% (0.9235)”, per the IRS Schedule SE).
Social Security tax is 12.4% of those earnings up to the wage base, which is $176,100 for 2025 (Publication 15, 2025) and $184,500 for 2026 (Publication 15, 2026). Medicare is 2.9% with no cap. Both rates sit in IRC 1401.
An extra 0.9% Medicare tax applies to self-employment income over $200,000 single or $250,000 joint under IRC 1401(b)(2).
Half of the Social Security and regular Medicare tax is an income tax deduction under IRC 164(f). It lowers income tax, and it does nothing to the self-employment tax itself.

A contractor netting $200,000 pays roughly $28,000 of this before any income tax, whether the money comes home or stays in the business account to fund the next job’s payroll.

How does the S-corp election cut self-employment tax?

It splits your profit into two buckets. You pay yourself a W-2 salary through payroll, and that salary carries Social Security and Medicare tax. Whatever profit is left comes out as a shareholder distribution with no payroll tax on it. The savings live in the gap between total profit and the salary, and the IRS polices that gap through the reasonable compensation rule covered in the next section.

The election itself is Form 2553. The instructions give the deadline as “no more than 2 months and 15 days after the beginning of the tax year the election is to take effect,” which for a calendar-year business means March 15, or any time during the prior year. A new LLC’s clock starts on the day its first tax year begins.
Miss it and the IRS can still treat the election as timely under Rev. Proc. 2013-30 if the company meant to be an S-corp from the start, everyone reported that way, you have reasonable cause, acted diligently once you found the mistake, and file the request within 3 years and 75 days of the intended effective date. That relief is common. It isn’t automatic.
Once the election is in, the company itself generally pays no federal income tax under IRC 1363(a); the profit flows to your return on a K-1. The company files Form 1120-S by the 15th day of the third month after year end, runs real payroll, and issues you a W-2.

Hypothetical example

Round numbers. A general contractor with one owner, filing single, nets $250,000 in 2026 before paying herself anything.

As a sole proprietor or disregarded LLC: net earnings from self-employment are $250,000 x 92.35% = $230,875. Social Security is 12.4% of the first $184,500 = $22,878. Medicare is 2.9% of $230,875 = $6,695. The 0.9% Additional Medicare tax hits the $30,875 above $200,000 = $278. Total self-employment tax: about $29,850. Half of the Social Security and regular Medicare piece ($14,787) is an income tax deduction; it doesn’t reduce the $29,850.

As an S-corp paying a $110,000 salary: Social Security is 12.4% x $110,000 = $13,640 and Medicare is 2.9% x $110,000 = $3,190, so payroll tax is $16,830, half withheld from her paycheck and half paid by the company and deducted on its return. No Additional Medicare tax, because wages are under $200,000. What’s left after the salary and the company’s $8,415 share, about $131,600, comes out as a distribution with no payroll tax.

Payroll-tax saving: $29,850 minus $16,830 is about $13,000 a year. The income-tax side takes part of it back. The sole proprietor deducts half her SE tax ($14,787) and takes QBI on the whole profit (capped at 20% of taxable income, about $43,800 here); the S-corp deducts only the employer half of payroll tax ($8,415) and takes QBI only on the $131,585 that isn’t salary ($26,317). That’s about $23,900 more taxable income on the S-corp side, roughly $5,700 of income tax in the 24% bracket, so the saving is closer to $7,300 before the cost of running payroll and filing Form 1120-S. Our read is that those costs run $3,000 to $6,000 a year for a small contractor, so the net gain is roughly $1,000 to $4,000. The number scales with the gap between profit and salary, and it shrinks fast: at $120,000 of profit and an $80,000 salary, the payroll-tax saving is under $5,000 and the lost QBI and half-SE deduction eat two thirds of it, leaving about $1,500 before costs. The election pays when profit runs well past the salary you’d have to pay yourself, and it has to be modeled on both layers rather than on payroll tax alone.

Illustrative numbers only, not a real client and not advice for your facts.

What salary does the IRS consider reasonable for a contractor?

Roughly what you’d have to pay someone else to do your job. IRS guidance says an S corporation must pay reasonable compensation to a shareholder-employee for services “before non-wage distributions may be made,” and the factors it lists include training and experience, duties and responsibilities, time and effort devoted to the business, and what comparable businesses pay for similar services. For a hands-on contractor that usually means what a project manager or superintendent earns in your market.

The guidance is on the IRS page on S corporation compensation, which also quotes the Form 1120-S instructions: distributions and other payments to a corporate officer “must be treated as wages to the extent the amounts are reasonable compensation for services rendered.” That’s the reclassification risk. When the salary is indefensibly low, the IRS recharacterizes distributions as wages and assesses the payroll tax, penalties and interest on the reclassified amount, which usually costs more than paying a fair salary would have.

How does the QBI deduction work for construction companies?

Owners of pass-through businesses can deduct up to 20% of qualified business income under IRC 199A, and the One Big Beautiful Bill Act made the deduction permanent by striking the old sunset after 2025. Construction isn’t a specified service business, so a contractor never loses the deduction just for earning too much. What can shrink it above the income threshold is the W-2 wage and property limit, and the thresholds in the table decide whether that limit applies at all.

Filing status	2025 threshold (limit starts)	2025 fully phased in	2026 threshold (limit starts)	2026 fully phased in
Single (married filing separately is $25 higher in 2026)	$197,300	$247,300	$201,750	$276,750
Married filing jointly	$394,600	$494,600	$403,500	$553,500

The 2025 figures are from Rev. Proc. 2024-40 and the 2026 figures from Rev. Proc. 2025-32. The wider 2026 range is the OBBBA change: the phase-in band grew from $50,000 ($100,000 joint) to $75,000 ($150,000 joint) for tax years beginning after 2025, per 199A(b)(3)(B).

The specified service list comes from IRC 1202(e)(3)(A) as applied by 199A(d)(2): health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any business whose principal asset is the reputation or skill of its employees or owners (engineering and architecture are on the 1202 list but 199A carves them back out). A general contractor, plumber, electrician, roofer or excavation company is none of those.

Below the threshold the deduction is 20% of QBI, capped at 20% of your taxable income before this deduction (less any net capital gain), and for a sole proprietor taking the standard deduction that cap is usually the binding number. Above the top of the range, 199A(b)(2) caps it at the greater of 50% of the W-2 wages the business paid, or 25% of those wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property. For a contractor that plays out like this.

Your own W-2 salary is W-2 wages for this test, and so are the wages of crews, estimators and office staff. A shop with real payroll rarely hits the cap. A shop that subs everything out and pays only the owner can.
UBIA is original cost, and it keeps counting until the later of 10 years after the placed-in-service date or the end of the asset’s recovery period (Reg. 1.199A-2(c)(2)). An excavator you fully expensed under Section 179 or bonus depreciation five years ago still carries its full cost into this calculation.
Raising the owner’s salary raises the wage limit and costs payroll tax at the same time. Whether that trade nets out positive depends on your marginal rate, which is why it gets run every year rather than set once.

Hypothetical example

Round numbers. An electrical subcontractor runs as an S-corp with $400,000 of qualified business income in 2026. The owners file jointly with taxable income of $700,000, above the $553,500 top of the range, so the wage limit applies in full. Payroll is $350,000 of W-2 wages ($100,000 owner salary plus $250,000 to the crew) and the company owns $600,000 of UBIA in trucks and equipment.

Tentative deduction: 20% x $400,000 = $80,000. Wage test (a): 50% x $350,000 = $175,000. Wage test (b): 25% x $350,000 + 2.5% x $600,000 = $87,500 + $15,000 = $102,500. The cap is the greater, $175,000, which exceeds $80,000, so the full $80,000 deduction survives.

Same company, but the field work is all subcontracted and the only W-2 wages are the owner’s $100,000. Test (a): $50,000. Test (b): $25,000 + $15,000 = $40,000. The cap is $50,000, so the deduction drops from $80,000 to $50,000. At a 35% marginal rate the lost $30,000 of deduction is about $10,500 of extra federal tax. Lifting the salary to $160,000 restores an $80,000 cap (50% x $160,000), but the extra $60,000 of wages and the company’s $4,590 share of payroll tax on them also come out of QBI, which drops to about $335,400, so the deduction lands near $67,000, not $80,000. The extra wages cost $9,180 in payroll tax at 15.3%, still under the Social Security wage base, and the company’s half of that is deductible. At 35% the recovered deduction is worth about $6,000 and the deductible employer share about $1,600, against $9,180 of payroll tax, so on these numbers the raise loses about $1,600. A smaller raise, or a spouse who already works in the business going on payroll, changes the answer, which is why it gets modeled rather than guessed.

Illustrative numbers only, not a real client and not advice for your facts.

The broader mechanics of the deduction, including how it interacts with a Canadian side of the file, are in the Section 199A guide.

Which entity pays the least tax: sole proprietor, S-corp or C-corp?

For an owner who takes the profit home each year, the S-corp. The C-corp’s flat 21% rate under IRC 11(b) looks good until profit comes out as a dividend and gets taxed again on your return under IRC 301(c)(1). At the top bracket that’s 21% at the company plus up to 23.8% on the dividend, about 39.8% of the original profit, with no QBI deduction anywhere in the chain.

	Sole proprietor or single-member LLC	LLC or corporation taxed as S-corp	C-corp
Payroll or self-employment tax base	All net profit (92.35% of it)	Owner’s W-2 salary only	Owner’s W-2 salary only
20% QBI deduction	Yes, subject to the wage limit above the threshold	Yes, owner salary counts as W-2 wages for the limit	No
Tax on profit left in the business	Your individual rate	Your individual rate	21%
Second layer when profit is paid out	None	None (distributions are tax-free to the extent of basis)	Dividend taxed on your return, up to 23.8%
Federal filings	Schedule C on your 1040	Form 1120-S plus payroll returns and W-2s	Form 1120 plus payroll
Liability shield	Sole prop: none. LLC: yes	Yes	Yes

The 23.8% is the 20% top rate on qualified dividends in IRC 1(h) plus the 3.8% net investment income tax in IRC 1411. The C-corp starts to make sense when a firm intends to leave most of its profit inside the company for years to build equipment, working capital and bonding capacity, because the 21% rate on retained profit beats the individual rate on the same income. Any money that later comes out still faces the second layer, so it’s a modeling exercise for firms netting well into six figures with a real retention plan, and it’s the wrong default for everyone else.

Established contractors often run two entities either way: the operating S-corp that bids jobs, holds the license and employs the crews, and a separate LLC that owns the excavators, trucks and the yard and leases them back at a market rate. A jobsite judgment against the operating company then stops at the operating company’s assets, provided the entities keep separate bank accounts, separate books and a written lease. The equipment stays visible to the surety through the indemnity agreement, so bonding capacity usually doesn’t suffer; the bonding and surety guide covers how the underwriter reads the two balance sheets. The second entity also makes a sale cleaner: the buyer takes the contracts, license and workforce, and you keep the fleet and the lease income. Under about $1 million of revenue with a small fleet, the second set of books usually costs more than it protects.

Do state taxes change the S-corp math?

Sometimes by enough to matter. A few states charge the S-corp itself a tax that a sole proprietor never pays, and that cost comes straight off the payroll-tax savings, so it belongs in the break-even before you file the election. Going the other way, most states now offer a pass-through entity tax election that turns state income tax into a full federal deduction outside the SALT cap.

California taxes every S corporation with California source income at 1.5%, with an $800 minimum franchise tax (California FTB).
Illinois levies a 1.5% personal property replacement tax on S corporation net income (Illinois Department of Revenue).
New York City doesn’t recognize the S election at all and taxes federal S corporations under its general corporation tax (NYC Department of Finance).

The other direction helps. Most states now offer a pass-through entity tax (PTET) election that lets the S-corp pay state income tax at the entity level. Under IRS Notice 2020-75, those payments are “not taken into account in applying the SALT deduction limitation” on the owner’s personal return, so the state tax becomes a full federal deduction instead of a capped one. The cap itself is $40,000 for 2025 and $40,400 for 2026 under IRC 164(b)(7), phased back down toward a $10,000 floor once modified AGI passes $500,000 ($505,000 in 2026). A contractor in a 5% to 9% state who is over the cap, or over the phase-down, can pick up thousands a year from the PTET election. Details and elections differ by state and change often; the One Big Beautiful Bill Act guide covers the federal side of the cap.

What should I do next?

If you’re a sole proprietor or single-member LLC and net profit has run well past a reasonable salary for two years, model the S-corp election on your own numbers, including the QBI and half-SE-tax effects and your state’s entity-level tax, before March 15. If you already have the S-corp and no written support for your salary, build the compensation file this month. If your taxable income is above the QBI threshold, run the wage-limit test before year end, when there’s still time to adjust December payroll.

Equipment decisions feed both the QBI limit and the balance sheet the surety reads: Section 179 and bonus depreciation for construction equipment.
The entity choice sits on top of the accounting method and WIP schedule: contractor tax deductions and WIP accounting and job costing for tax compliance.
If the “subs” on your jobs look like employees, the QBI wage fix isn’t the only issue: worker classification penalties for contractors.
Work across state lines and the entity follows you into every one: multi-state nexus, withholding and sales tax for contractors.
The same S-corp and multi-entity analysis for restaurants and trucking owner-operators, if you want a side-by-side.

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Cite this page

Yarik Yarosh, CPA. "Construction Company Entity Structure: LLC vs S-Corp and the QBI Deduction for Contractors." Blue Cloud CPA, August 27, 2026, updated September 23, 2026. https://bluecloudcpa.com/guides/construction-entity-structure-llc-scorp-qbi-deduction

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.