There are certain benefits to being taxed as an S Corp. S-corp only saves you from FICA taxes by allowing you to lower your wages to the industry average. Useful if you were making 150k, that way you could “pay” yourself 60k and pay self-employment on that. S-corp comes with a lot more baggage in terms of papers that you need to report and file.
Why is an S-Corp better for taxes in some cases?
S-corp taxes count as an income distribution. What it basically means is that you pay all of the income taxes you would normally owe, but nothing for SS and Medicare. It is probably the most efficient tax vehicle you can possibly have for a medium-large company, as your total liability tops out at the top income tax rate (~40%). Capital gains is technically more efficient (~20%), but corporate tax has to be paid first, which matches the top income rate. Most big corporations pay something like 25-40% of their profits, then the investors have to pay another 20% for dividends and 20% for capital gains. If the capital gains / dividends are unqualified (short-term), then you pay up to the top-income rate (~40%).
Differences between S-Corp and LLC
So if you made 100 million a year in profit, you would pay 40 million as an s-corp/llc, or 40 million plus 20 million for dividends as a c-corp.
If you made 100k a year and had an LLC, you would pay federal income and FICA on 100k of your income.
If you made 100k a year and had an s-corp, you could pay yourself a salary of 50k, then you would pay federal income on 100k, but only pay FICA on 50k, saving yourself about 6k a year.
One of the nice things about an s-corp is that it’s a bit easier to distinguish company assets from personal assets. You file your company taxes, then your own. With an LLC, you file only personal taxes, but include a schedule C for your business expenses. It is very important then that you specify which assets belong to the company and which are your own.
What should Small Business Owners be thinking about?
You might be able to get away with paying the salary thereby doing the payroll tax withholding along with the SS and Medicare tax on both corporate side and “employee” side and then do a loan right back in for the amount of your net. I would make darn sure of three things when I did that.
- 1) Write down/document the loan
- 2) Charge the appropriate Applicable Federal Rate (AFR)
- 3) Repay or make a big effort to repay loan with interest before taking distributions
Other Reasons to have an S Corp
There maybe some other tricks, i can think of some others, but I would make sure I talked to CPA first as the IRS in on the warpath after Sub Chapter S corps trying to classify wages as distributions. The tax courts have been taking the salary requirement right up to the SS cutoff. NOT worth playing with wages and distributions for a Sub S when you work there full time.