If you’re a small business owner, you may have heard several times that to save on your taxes, you will want to obtain S-Corp status for tax filing. This is not a one-size-fits-all choice, however, as depending on how much income your business is bringing in, you may be better with having your business set up as a C-Corp.
So, what is an S-Corp?
An S-Corp is an entity that has elected to pass it’s income and losses onto it’s shareholders. There are strict rules with the IRS to maintain S-Corp status including having no more than 100 shareholders and commitment of the owners to being employees of their own company.
Why do people elect to do this?
It saves them money on taxes in several cases.
Let’s say, for example, an LLC is bringing in a net income of $100,000. If the owner is not filing taxes for their company as an LLC, they will owe self-employment taxes (for social security and Medicare) at 15.3% of their earnings, as well as income tax of $10,294 plus 22% of any amount over $89,450. This results in taxes owed of approximately $27,915.
Now, if the LLC was filing as an S-Corp, the owner would pay themselves a “fair” salary where the company and the owner would pay payroll taxes (this still results in 15.3% total for social security and Medicare taxes), as well as income tax on the employee/owner. The remaining amount in net income for the S-Corp is only subject to income tax. So let’s break down those numbers…
If the owner pays themselves $50,000, the TOTAL for payroll taxes will be $7,650. Having $50,000 puts them in a tax bracket making them liable to pay $5,560 in income tax. The remaining $50,000 for the S-Corp is only subject to $5,560 in income tax. Under this structure, the S-Corp owes a total of $18,770. The S-Corp saves them almost $10,000 in taxes as opposed to filing as an LLC.
If you’re wondering why you can’t claim $0 to salary and avoid payroll taxes as an S-Corp, its because the courts already caught on to that long ago after a case in 2001 and agreed that any draws the owner takes from the company are to be treated as payments to an employee and are therefore subject to payroll tax (we know, we don’t like it either, but it is what it is in this case).
This is a great option for several businesses, however, it is not always the most effective when it comes to saving on taxes. As of now, the corporate tax rate is 21%. Income tax is 22% for any amount over $89,450, and this is NOT the lowest tax bracket.
Companies bringing in hundreds of thousands of dollars need to take this into consideration. Let’s change our figures and say that this LLC I mentioned is now bringing in $500,000. Let’s say the owner is still taking that $50,000 salary, resulting in a total of $13,210 in taxes (payroll and income). Now, there is $450,000 that is subject to income tax. It is subject to $101,664 in income tax (yikes).
If that LLC is converted to a C-Corp, the owner could still take that $50,000 salary and owe $13,210 in taxes between them and the corporation, and the remaining $450,000 would be subject to $94,500.
Deciding on how your company will be taxed is a big decision and should be discussed first with your CPA.
Needing a consult to figure out how to tax your entity? Contact us to schedule a meeting with one of our CPAs!