How an S-Corporation Can Save You Thousands in Self-Employment Taxes

Are you paying too much in self-employment taxes? If you’re self-employed and earning significant income, the right business structure could save you thousands each year. An S-Corporation may be the solution you need.

What Is an S-Corporation?

An S-Corporation is a special tax designation that allows eligible corporations and LLCs to benefit from “pass-through” taxation while avoiding double taxation faced by traditional C-Corporations. This structure opens up strategic tax planning opportunities, particularly for reducing self-employment taxes.

The Key Advantage: Avoiding Self-Employment Taxes on Distributions

S-Corps can pay owners through a combination of salaries and distributions:

• Salaries: Owners must receive reasonable compensation for their services, subject to payroll taxes.

• Distributions: Remaining profits can be distributed without self-employment taxes because distributions are considered a return on investment rather than earned income.

Tax Savings Example

A business earning $200,000 annually:

• Sole proprietor: Entire $200,000 subject to self-employment taxes.

• S-Corp:

• Salary: $120,000 (subject to payroll taxes).

• Distribution: $80,000 (avoids self-employment taxes).

• Annual savings: $12,240 (15.3% of $80,000).

What Constitutes “Reasonable Compensation”?

The IRS requires S-Corp owners to receive “reasonable compensation” as wages. To meet IRS standards, your salary should reflect your role’s market value, the time you invest, and your business’s profitability.

Factors to consider include:

• Industry standards for similar roles.

• The time and effort spent on the business.

• The business’s profitability.

Important Considerations Before Election

Administrative Costs

• Separate corporate tax return (Form 1120-S).

• Regular payroll processing and tax filings.

• More complex bookkeeping requirements.

State Tax Considerations

• Varying state tax treatment of S-Corps.

• Additional franchise or entity-level taxes.

• State-specific filing requirements (e.g., California’s franchise tax).

Ownership Rules

• Limited to 100 shareholders.

• Shareholders must be U.S. citizens or residents.

• No corporate or partnership shareholders.

• Only one class of stock allowed.

Is an S-Corporation Right for Your Business?

The S-Corporation structure can offer significant tax benefits for many business owners. However, success depends on proper implementation and compliance. I specialize in helping entrepreneurs optimize their business structure and tax strategy.

Ready to explore whether an S-Corporation could benefit your business? Contact me at paul@hessquire.com or connect with me on LinkedIn to discuss your specific situation.

Disclaimer: This post provides general information about S-Corporations and tax planning strategies. Every business situation is unique. Please consult with qualified tax and legal professionals before making any decisions about your business structure or tax strategy.