By: Silver Fox Accountancy
S-Corp status is a popular choice and is often highly recommended to small business owners to reduce their tax liabilities. However, this is not a one-size-fits-all choice as depending on how much income that business is bringing in, they may be better off with having their business set up as a C-Corp.
What is an S-Corp?
An S-Corp is an entity that has elected to pass its income and losses onto its 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?
In several cases, this election saves business owners money on taxes. For example, an LLC may be 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. 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.
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. Business owners cannot claim zero pay to owners as a means to avoid payroll taxes. The courts ruled against this tactic in 2001 and now force any draws taken by owners to be salary payments subject to payroll taxes for both the company and the owner. 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. If an LLC is bringing in a net income of $500,000, and the owner is taking a $50,000 salary, resulting in a total of $13,210 in taxes (payroll and income). Now, there is $450,000 that 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. In this case, the C-Corp is the “tax friendly” option.
A company’s decision on how it will be taxed is not one to take lightly. Therefore, it can have a large impact in the short and long-run and should always be discussed first with a licensed CPA.
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