McVay Business Services - Accounting & Tax Services Pensacola, FL
How Can an S Corp Help?
Creating an S Corp, or an LLC taxed as an S Corp, allows you to hire yourself as a W-2 employee and split your earnings between salary and distributions.
In this strategy, you only pay the 15.3% SE tax on the part of your income considered salary, not on the distributions.
It is important to note that the wage or salary you pay yourself must be reasonable, otherwise the IRS might charge you back taxes and penalties (i.e. your wages can’t be $1 and dividends $99,999).
Example: Jane is a real estate broker with earnings of $167,830 for the 2017 tax year. If she were simply a sole proprietor, then all of her income would be considered wages, and up to $118,500 would be subject to the 15.3% SE tax – totaling $18,130.50.
However, if she were to set up an LLC and elect to be taxed as an S Corp, she can split the earnings between salary and distributions. With the help of her CPA, they determine $65,000 to be a reasonable salary. This means that she will only pay the SE tax on $65,000, saving $8,361.
Potential Pitfalls of this Strategy
Of course, Uncle Sam wants his money, so it’s never that easy.
Service companies are more likely to be scrutinized by the IRS when using this strategy because most of your earnings come from personal efforts, and not of that of other employees. That is why it is imperative to work with your CPA to research and document the reasons behind the reasonable salary you decide to pay yourself.
The IRS requires companies with W-2 employees to pay Federal Unemployment Tax (FUTA) of 6.20% on the first $7,000 of income for each employee. In some states you could also be subject to the State Unemployment Tax (SUTA). Once you implement this strategy, you will considered a W-2 employee and will have to pay this tax.
Since the S-Corp is a separate entity, a separate tax is required, which comes with additional tax preparation costs. Also, S Corps have other compliance requirements such as setting up a board of directors and holding meetings.
The Bottom Line
Creating an entity and electing to be taxed as an S Corp has its advantages and can potentially lower your tax liability, but may not be for everyone.
There are costs involved with setting up and maintaining the entity, which will have to be weighed against the actual tax savings you will receive. In many cases this strategy will make sense for higher income earners.
You will want to discuss the advantages and disadvantages this strategy with a qualified tax professional to find out if this makes sense for you. McVay offers a complementary consultation to evaluate your situation to see if you are eligible for this great tax benefit. Mike McVay, Tax Accountant * Mike@MikeMcVay.com
Mike McVay, Tax Accountant Mike@MikeMcVay.com
Mike McVay, Tax Accountant Blog
Certified QuickBooks ProAdvisor & Licensed Tax Accountant Pensacola, FL
©2021 this website and all of its sub domains are owned and operated by
Subscribe to our newsletter