What are the tax benefits of S-Corps?
Today, we’re going to answer that question and more!
And here’s a quick note:
We recently saved our client over $95,000 in taxes by making one small change – you guessed it right, helping her switch from an LLC to an S-Corp.
And if you are still being taxed, let’s say as an LLC instead of an S-Corp, you may be giving uncle sam a bit more money than you have to.
So, if you want to know more about how S-Corps work and all of the tax benefits of S-Corps that will put money back in your pocket, you are in the right place.
Now, we have to warn you that even with all of the tax benefits of S-Corps, they are not the right choice for everyone.
So make sure you read this whole post because we’ll be touching on what factors determine if an S-Corp is right for you later.
Also, the information in this post is solely for educational purposes only. You’ll want to consult with a CPA, or your tax and legal advisor regarding your specific business.
Ready to talk S-Corps? Let’s go!
4 Tax Benefits of S-Corps
Before we dive into the tax benefits of S-Corps, first just keep in mind that S-Corporation status is a tax designation, so you can’t ‘incorporate’ as an S corp but you can elect to be taxed as one.
Tax Benefits #1: Employment Tax Savings
Owners of S-Corporations get to receive both salary and dividend payments aka distributions from earnings and profits.
This is a huge deal and let’s unpack why.
Well with an S-Corp, you only pay self-employment taxes, which is 15.3% currently, on the salary paid to the owners.
Your dividends are safe from self-employment tax.
So you see the IRS is hip to such thinking and requires that your salary is reasonable and align with your actual responsibilities of the business.
The easiest way to figure out how to pay yourself and what is reasonable is to use comparable salaries for your job position.
So as an example, if you are a doctor that owns a practice, and most doctors in your area make $100,000, then it wouldn’t be reasonable to pay yourself only $30,000.
Other factors that determine a reasonable salary are:
- Experience level
- Comparable salary
- Geographic location
- Economic conditions
But even if you can’t get away with paying yourself $1 in salary, the tax savings can still be tremendous.
Let’s look at an example and truly paint a picture of how switching to an S-Corp and changing how you receive income can lead to tax savings:
|Active Owner of an LLC Taxed as a Partnership||Active Owner of an LLC Taxed as an S-Corporation|
|Gross Earnings||$100k as an LLC Distribution||$40k Salary & $60k Distribution|
|FICA taxes||$0||$6,120 (15.3% or 40k)|
|Self-employment Taxes||$15,300 (15.3% of 100k)||$0|
|Income Before Fed & State Taxes||$84,700||$93,880|
Say you are a Customer Support Rep for your company and you make an income of $100k in gross earnings.
If you choose to be an LLC taxed as a normal partnership, your entire $100K will be taxed at the current self-employment rate of 15.3%.
Before taking out Federal and State taxes, you are left with $84,700.
BUT if you were to elect to be taxed as an S-Corporation and took a salary of $40k and the rest in distributions, only the $40K would be subject to self-employment taxes.
This leaves you with $93,880 before taking out Federal and State taxes.
OR $9,180 more in your pocket simply because you choose to be taxed as an S-Corporation.
Note, that’s $9,180 more income, even after you take out Federal and State income taxes.
In short, S-Corps can greatly reduce your self-employment tax obligation by only paying self-employment tax based on your salary and not on the total business income.
Tax Benefits #2: Pass-through Taxation
As an owner of an S-Corporation,
- business income,
- and losses
…get passed through to owners instead of being taxed at both the corporate level and at the shareholder level – essentially avoiding the double taxation that C-corporations are subject to.
This is similar to an LLC.
Speaking of losses, if your S-Corp loses money, those losses are then deductible on your personal income returns.
As an example, if you are the sole owner of an S-Corp, and the business suffered a loss of $10,000, you would be able to take a $10,000 deduction on your tax return, meaning the loss can offset any other income that you received.
Tax Benefits #3: Low Risk of Audit
Since 2010, S-Corp audits have dropped about 34%.
According to the IRS, audit rates for S-Corps in 2018 were 0.22%. To put it in perspective, that is one in every 459 S-Corps were audited.
This is extremely low.
Tax Benefits #4: Asset Protection
One other benefit of an S-Corporation to be aware of is that S-Corps provide owners limited liability protection just like an LLC would. If you want to know more about the tax benefits of LLC, then read this post next.
So this means that an owner’s personal assets such as homes, cash, and cars are protected against lawsuits for example.
Is an S-Corp Status Right For You and Your Business?
To help you determine that, answer these three questions!
#1: Do I make enough profit for S-Corp status to be beneficial?
If after paying yourself a reasonable salary, you have only $2,000 to pay yourself as a distribution, it’s likely not worth the added effort and extra paperwork to be treated as an S-Corp.
Remember the biggest benefit of an S-Corp is the ability to not pay self-employment taxes on your distributions. If you have minimal distributions, then you won’t receive a major benefit.
#2: Do I plan to withdraw most of the profit from my business?
If you plan to take most of your profits as a distribution, then S-Corp status might be right for you.
If you plan to re-invest most of the profits back into your business, leaving very minimal profit, S-Corp status likely does not make sense.
#3: Does my state recognize S-Corps?
S-corps aren’t treated equally by every state. States such as New Hampshire, Tennessee, and Texas ignore S-corporation status and tax them as C-corporations.
You will want to check with your CPA or tax consultant to determine if S-Corporation status is for you.
Now, if after answering those two questions, you decide to elect to be taxed as an S-Corp, here is how to do it.
S-Corp Eligibility Requirements
– Maximum of 100 shareholders
– Must be a US company
– The shareholders must be US residents
– There can only 1 class of stock
If you meet the eligibility criteria, here’s how to elect to be an S-Corp:
If you’re electing S-Corp status as an LLC, you will need to file Form 8832, Entity Classification Election, with the IRS by March 15th for it to take effect in the current tax year.
If you’re electing S-Corp status as a C-Corporation, you must submit Form 2553, Election by a Small Business Corporation to the IRS, with the IRS by March 15th for it to take effect in the current tax year.
So those are the major tax benefits of S-Corps. And here are the major points to remember:
1. S-Corporation status is a tax designation, so you can’t ‘incorporate’ as an S corp but you can elect to be taxed as one.
2. S-Corps only pay self-employment taxes on the salary paid to the owners, not the dividends or distributions.
3. Business income, credits, and losses get passed through to owners of an S-Corp.
4. S-Corps have a very low chance of being audited by the IRS.
We hope this post will help you determine if an S-Corporation is the right fit for your business, and so you can take advantage of the tax benefits of S-Corps.
If you need more assistance with your tax preparation and tax filings, we’ve got you covered. Contact us today!