Save tax with S-Corp

An S-Corporation, is a common entity to save taxes, and most small business owners, professionals, practitioners etc. should be using them as their entity of choice.

A S-Corp is a tax designation available to corporations and LLCs. S-corps are named from the subchapter of the Internal Revenue Code—subchapter “S”—under which the tax designation is spelled out. 

When to have an S-Corp over LLC?

Here are the S-Corp advantages that might help you to decide

1- Do you have income subject to self employment- tax? 

The first question I ask clients is if they have income subject to SE tax.  Self-employment income is often referred to as ‘ordinary income’ derived from services or the sale of products. Ordinary income IS NOT income from a W-2.

Few examples of ordinary income is Realtor, Dentist, Doctor, Marketer, Hair stylist, Attorney, Educator, Designer, 1099NEC or MISC etc..

Passive income IS NOT subject to SE tax. Passive income is rental income, interest, dividends, capital gain, etc.

2-How much ordinary Income do I need before forming an S-Corporation? 

I generally advised my clients that the break-even point is approximately $30-$40k in net income.

If your business is making net ordinary income subject to SE tax of $40k or more then you are a candidate for an S-Corporation. The reason why I feel this is the ‘break-even’ point is because of the salary/net-income allocation and S-Corp set- up, filing additional business return and payroll expenses. I tailor payroll allocations to each business owner and their situation. There can be $3000 or more in savings. 

What will be the cost of S-Corp ?

The S-corp set up cost can range from $150-$700. It IS NOT simply a ‘filing of articles, there are multiple documents and steps to include.

Next, you have the ongoing maintenance and the monthly and annual tax filings. With it you will be paying yourself a salary. Even if you don’t have other employees you will have to do payroll and file quarterly payroll reports with the IRS. It also must file its own year-end tax return and issue you a W-2. These annual costs could range from $1,000-$1500 depending on your situation.

What are the benefit of S-corp? 

Here are the top benefits of becoming an S-corp

1- Saving on Self-Employment tax-(SE TAX)-The main benefit of an S-Corporation is to honestly and ethically save on Self-Employment Tax (SE Tax). SE tax, also referred to as FICA, consists of Medicare and Social Security taxes totaling a 15.3% hit on your bottom line. In a sole proprietorship or an LLC taxed as a sole proprietorship, SE tax is applied to every dollar of net self-employment income reported on Schedule C or earned on a K-1 from a partnership.

In an S-Corporation, net income is split into a salary portion and a pass-through or net-income portion. They are pass-through entities (just like LLCs); so all the income it earns DOES NOT pay corporate tax. Along with any income is taxable to the individual owners in the year earned and is subject to ordinary income tax rates. However, in an S-Corporation, SE tax only applies to the salary, not on the net income. This means that for every thousand dollars you classify as pass-thru income, you save $150 in taxes!

Okay, time for an example. Let’s say Lila is self-employed and makes $100,000. So, she would owe $15,300 when it comes time to pay self-employment tax. If Emily earns the $100,000 through her S corp and pays a reasonable salary of, say, $40,000, only that $40,000 in wages is subject to Social Security and Medicare taxes. Through the S corp, her Social Security and Medicare taxes would be 15.3% (7.65% employer and 7.65% employee portion) totaling $6,120. Compared to the self-employed taxes, she would save $9,180 in taxes.

2- Employee Expenses Deduction under an Accountable Plan- Under current tax laws, employee can not deduct out of pocket business expenses on their personal return. For an S-Corp with shareholder employees, out of pocket business expenses can be paid by the employee and reimbursed by the S-corp. To do this the S-corp  must set up and Accountable Plan, which used for reimbursing workers for business expenses. An Accountable plan requires expenses to be substantiated for business purpose. These expenses can include home office, rent car mileage, cell phone, internet etc..

3- Retirement Planning-  An S-Corp owner individual or a married couple and without any other employees, can set up a Solo 401K plan and defer up to $20,500 of income (Per Individual) from taxes in 2022. With an SEP IRA and S-corp can contribute up to 25% of an employee’s compensation. Contribution must be made on or before the tax return due date. 

4-AND a decreased chance of an audit. That’s right! Estimates are that S-Corps are 15x less likely to receive an audit than a LLC/Sole proprietor, even though they save more in taxes!

LLC Taxed as an S-Corporation

An LLC ‘taxed as an S-Corp’ is the same thing as a standard S-Corporation set-up as an ‘Inc’. The IRS considers them to be the same.

When you convert to an S-Corporation (with a properly filed IRS Form 2553), your name won’t change with the State. You will still have the acronym ‘LLC’ at the end of your company name – and that’s OK!!

The main reason why business owners may start or begin their business with the LLC entity is so they can ‘convert’ or ‘elect’ to the S-Corporation when the time is right. This is an affordable process. Until the ‘election’ is made, the LLCs are taxed as a sole proprietorship or partnership.

But Remember, an LLC (Limited Liability Company) doesn’t save taxes whatsoever!! That is why we want to convert to the S-Corporation.

The S-Corporation is ultimately the best entity for an operational business owner in the long run. Don’t underestimate the power of the S-Corporation. Please reach out our office if you have any questions.