Maybe it’s time to consider the S Corp Election. The benefit of the S Corp election is that your profits -- after you pay yourself reasonable compensation -- are not subject to self-employment/payroll tax (only income tax). Self-employment tax is 15.3% of your profits, but with an S Corp election, you can skip that tax on a decent chunk of what your business makes every single year.
So what’s the downside? An S Corp has slightly more administrative burden than a regular sole proprietor or single-member LLC (This is why I’ll only recommend an S Corp where the potential benefit far outweighs this burden).
Bottom line? The S Corp election may save you thousands of dollars in taxes every year, but do not do S Corp alone. There are specific rules, deadlines and procedures you need to follow to properly make your S Corp election. Sounds confusing, right?
You’re making $50k+ in your business
You already have a C Corporation or LLC or are planning on forming one
You want to save potentially thousands of dollars in taxes!
No! An S Corp is not an entity at all; instead, it’s a tax classification that you elect for an existing entity. In order to make the S Corp election, you must have a C Corporation or LLC, and that entity elects to be classified as an S Corp for tax purposes. So making this election doesn’t change the legal makeup of your company.
Because the S Corp benefit (no self-employment taxes) only kicks in after you pay yourself reasonable compensation. This means you need to have sufficient profits in the business to afford to pay yourself this reasonable compensation and then some.
Let’s say your business has profits of $100,000 and we determine your reasonable compensation is $60,000 (more on that later). If you were a plain old LLC with no S Corp Election, you’d pay both income tax and self-employment tax (15.3%) on the full $100k. But with the S Corp election, after paying yourself via payroll (a deductible business expense when you’re an S Corp), you have $40,000 in profits remaining. Those $40k in profits are only subject to income tax, NOT self-employment tax. So you’ve just saved yourself 15.3% on $40k (not factoring in the lost deduction for 50% of that self-employment tax).
There are a few additional requirements for S Corps. First, you have to put yourself (and any other owners who do work in the business, on payroll, which means not only processing payroll on a regular basis but also likely paying for a payroll service ($30-$100/month). Second, you have to file and pay payroll taxes to the Federal government and the state - this is something your payroll system will handle for you, but it still requires a bit of admin work to set up and manage.
Next, unlike your sole proprietorship or single-member LLC, whose income is reported, for tax purposes, on Schedule C in your personal tax return, the S Corp has to file a separate tax return. It’s an information only return, meaning you don’t pay taxes on it, but it’ll still be extra work (and possibly extra cost if you have a tax preparer) to prepare the return. Lastly, expenses that have a personal and business component (like your cell phone/internet, vehicle or home office) are treated differently. You’ll still likely get the full deduction, but you need to take a few additional steps to get there.
If you’ve got profits between $50-100k, we recommend starting with a Reasonable Compensation Report. This report tells you what you need to pay yourself via payroll before those S Corp benefits kick in. If the report comes back with $80k as your reasonable compensation and your profits are only $85k, maybe you hold off on the S Corp. You can book your Reasonable Compensation Report here. If you then decide to sign up for the S Corp Election Package within 6 months, the price of the Reasonable Compensation Report will be credited towards that cost.
Yes, I’m glad you asked. To qualify for S Corporation status, an entity must:
1) be a domestic corporation or LLC,
2) have only individuals or certain estates and trusts as its shareholders (no partnerships or corporations),
3) have only US citizen or resident shareholders,
4) have no more than 100 shareholders and
5) have only one class of stock.
Yes! Typically you must file within 75 days after the formation date of your LLC or C Corporation, or by March 15th for the election to take effect in the current year. While it’s possible to do a late filed election, we highly recommend you follow the deadlines above.
Have questions about if the S Corp Election is the right fit for your business? We offer S Corp Review Calls, where we’ll review your details and discuss whether an S Corp is the right fit for you. If you end up moving forward with our S Corp Election Package, the fee for this call will be credited towards your S Corp Election Package. Have questions about what’s included in the package? Email us at email@example.com.
Prepared and Filed S Corp Election Form
Reasonable Compensation Report
Payroll Set-up and Guidance, including registration with the state
S Corp Guide
1 hour strategy call with me
Unlimited access to ask me questions via Voxer for 90 days