There’s numerous options when it comes to picking the right entity structure for your business. It can be confusing for small business owners especially when there is an alphabet soup of options:
- LLC
- LLP
- S-Corporation
- C-Corporation
- Sole Proprietor, etc.
However, one of these filing options sticks out amongst others when it comes to saving money on self-employment tax.
Saving on Self Employment Tax
For small business owners and entrepreneurs, paying tax is a frustrating endeavor. Not only do you need to focus on the health and well-being of your business, but you also need to remember what tax forms to file. With the long list of taxes due at the end of the month, quarter, and year it can be difficult to remember:
- Sales Tax
- Payroll Tax
- Federal Income Tax
- State Income Tax
- Franchise Tax, etc.
Specifically, self-employment tax is one of the most costly tax for entrepreneurs. For 2018 the self-employment tax rate is 15.3% on the first $128,400 and 2.9% on every dollar earned above $128,400.
Owners of S-Corps can reduce that self-employment tax by paying themselves a reasonable salary and having the remaining income self-employment tax free. You will still pay ordinary income tax on the remaining bottom line but you can save thousands in self-employment tax.
Here’s How it Works
Let’s say you are the sole owner of your consulting business and you earn $250,000 a year after deducting applicable expenses. If you are registered as an LLC then you will likely pay self-employment tax, federal income tax, and state and local tax (where applicable) on the entire bottom line.
If you were structured as an S-Corporation then you could reduce some of that self employment tax by paying yourself a reasonable salary. Let’s say your position in the company would roughly pay $75,000 on the open market – if you paid yourself $75,000 out of your S-Corp then you could potentially save $10,000 in self employment tax.
That’s because only your salary and not the entire $250,000 would be subject to self-employment tax. This works great for business owners who have large profits but want to keep that money in the business. Taking a salary can make paying estimated tax easier as well as contributing to a retirement savings plan.
Consult With a Tax Advisor
Before switching over to an S-Corp you want to make sure to speak with a tax advisor. There are several other considerations when you are switching over to an S-Corp that can be counterintuitive to your business, for example:
- S-Corps require even distributions as a portion of ownership.
- Can only issue one class of stock.
- Can only have a limited number of owners.
- May have issues with built-in gains.
Any of the above can make switching to an S-Corp less than ideal for you business. Be sure to talk with a CPA or a trusted tax advisor before making any major business decisions, as they will be able to explain to you the whole picture.
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