Leveling Up Your Daycare: Should You Switch From a Sole Prop LLC to an S Corp in Texas?

The useful question is not “Is an S corp better?” It is whether the election makes sense for your actual numbers and circumstances.

Imagine a Texas-based daycare with $85,000 of gross income and $15,000 of business expenses. A simplified example would leave $70,000 of profit before considering owner compensation and tax elections.

The Texas Tax Picture

Texas does not impose a state individual income tax. Texas does, however, impose a franchise tax on qualifying entities. For the 2026 report year, the no-tax-due threshold is $2.65 million of annualized total revenue. Entities at or below that threshold generally do not owe franchise tax and do not file a No Tax Due Report, but they may still be required to file a Public Information Report or Ownership Information Report.

By the Numbers: A Simplified Illustration

This example is for illustration only—not a tax projection.

Scenario A: Single-Member LLC Taxed by Default

A single-member LLC that has not elected a different federal tax classification generally reports its business activity on Schedule C. Self-employment tax is generally calculated on net earnings from self-employment, using rules that include a 92.35% adjustment and Social Security/Medicare limits. Using $70,000 as a simplified net-profit figure, a rough self-employment-tax illustration would be approximately $9,916 before considering the Social Security wage-base rules and other factors.

Scenario B: S Corporation Election

An eligible LLC can elect S corporation treatment. The owner who performs services for the S corporation generally becomes a shareholder-employee and must receive reasonable compensation for those services before non-wage distributions are made.

If a hypothetical $40,000 salary were reasonable for the facts of the business, combined employee and employer Social Security and Medicare taxes on that salary would be approximately $6,120 before considering other payroll taxes. That amount is split between the employee and employer sides; it is not simply a $6,120 personal tax bill.

A remaining shareholder distribution may generally avoid self-employment tax when properly structured, but the distribution amount cannot be used as a substitute for reasonable compensation. The IRS can reclassify distributions as wages when appropriate.

What About the QBI Deduction?

The Qualified Business Income (QBI) deduction can allow eligible taxpayers to deduct up to 20% of qualified business income, subject to eligibility, taxable-income limits, and other rules. An S corporation’s reasonable compensation is not QBI, but the S corporation can pass qualified business income information to its shareholders through Schedule K-1. The distribution itself is not the definition of QBI.

The Trade-Offs

So, Should You Switch?

An S corporation election can be useful for some profitable daycare owners, but there is no universal income level at which it becomes the right choice. The analysis should consider reasonable compensation, payroll taxes, QBI, bookkeeping and tax-preparation costs, cash flow, compliance, retirement and benefit planning, and the owner’s overall tax situation.

Sources & Further Reading

• IRS — S Corporation Compensation and Medical Insurance Issues
• IRS — Qualified Business Income Deduction
• IRS — Form 1120-S Instructions
• Texas Comptroller — 2026 Franchise Tax Report Information

Reviewed September 2026. Tax rules can change; use current IRS and Texas guidance when making decisions.