Many small business owners are missing out on self-employment (SE) tax savings and you can see this for yourself by using our tax calculator here:
Sole Proprietorship Tax Calculator
Taxes Owed: $0.00
S Corporation Tax Calculator
Taxes Owed: $0.00
Slow down, how does this work?
Glad you asked, to start, most business owners start off as a sole proprietorship. Typically, this means less paperwork for the business owner, but they’re also taxed on whatever the company makes (since the business owner and the business are the same entity).
When you switch your business to an S Corporation, you must assign yourself a “reasonable” salary. This means that instead of being taxed on your business’s net income, you’re taxed on dividend earnings and do not need to pay corporate taxes.
If you are a sole proprietor, you may be considering switching to an S corporation. S corporations offer a number of tax advantages over sole proprietorships, including the ability to pay yourself a reasonable salary and take distributions on the remaining profits. This can save you a significant amount of money on self-employment taxes.
What is an S corporation?
An S corporation is a type of business entity that is taxed as a pass-through entity. This means that the profits of the business pass through to the shareholders on their individual tax returns. S corporations must have no more than 100 shareholders, and all shareholders must be individuals, estates, or trusts.
What are the tax advantages of an S corporation?
One of the biggest tax advantages of an S corporation is the ability to pay yourself a reasonable salary. As a sole proprietor, you are subject to self-employment taxes on all of your business income. Self-employment taxes are equal to 15.3% of your net income, up to a certain limit.
As an S corporation owner, you can pay yourself a reasonable salary, which is subject to Social Security and Medicare taxes. However, you will not be subject to self-employment taxes on your salary. This can save you a significant amount of money, especially if you have a high income.
Another tax advantage of an S corporation is that you can take distributions on the remaining profits of the business. Distributions are not subject to self-employment taxes. This means that you can save money on taxes by taking distributions instead of paying yourself a higher salary.
What is a reasonable salary for an S corporation owner?
The IRS does not provide a specific definition of a reasonable salary for an S corporation owner. However, there are a number of factors that you can consider when determining your salary, including:
- The industry in which you work
- Your experience and qualifications
- The salaries of similar positions in your area
- The profits of your business
It is important to note that the IRS may challenge your salary if it is too low. If youre business made $500,000 in revenue and your salary is $50,000 of that, that raises some red flags..
How to save money on taxes by switching to an S corporation
If you are considering switching to an S corporation, there are a few things you can do to save money on taxes:
- Pay yourself a reasonable salary. This will help you avoid paying self-employment taxes on your salary.
- Take distributions on the remaining profits of the business. Distributions are not subject to self-employment taxes.
- Work with a tax professional to ensure that you are complying with all of the IRS rules and regulations for S corporations.
Example
Let’s say that you are a sole proprietor with a net income of $100,000. You are subject to self-employment taxes on all of your income, which means that you will pay $15,300 in self-employment taxes.
If you switch to an S corporation, you can pay yourself a reasonable salary of $50,000. You will be subject to Social Security and Medicare taxes on your salary, but you will not be subject to self-employment taxes. You can then take a distribution of the remaining $50,000 in profits.
By switching to an S corporation, you will save $7,650 in self-employment taxes.
Whether you’re currently looking for an accountant or tax support for your business, we encourage you to check our latest information on how small businesses can save by simply electing to be taxed as an S-Corporation rather than a sole proprietorship. Watch our video below or calculate your savings using the tax form above.
Visit our Self-Employed Tax Guide for additional details and information.