Podcast: S-Corporations

S-Corporations

Written by Jeff Dvorachek

March 24, 2022

During this time of the year, we get a lot of questions from sole proprietors as to whether they should change the way they are taxed and whether they should look at becoming an s-corporation. And when I say sole proprietors it can be any type of entity that files their business taxes on their individual return. This would include single-member limited liability companies. So that is what I want to talk about today.

What is the difference between a sole proprietor and a single-member LLC?

  • In the eyes of the IRS, there is no difference as they consider both these entity types to be disregarded entities.
  • This means that all the income and expenses from the business are in the same pot as the owner’s wages, interest, dividends, etc.
  • From a legal point of view, the LLC gives you an extra layer of protection not afforded to sole proprietors.

How is the net income from these businesses taxed?

  • They are subject to income tax and self-employment tax which is essentially Social Security and Medicare x2.
  • As an employee, you pay SS and Medicare tax. Your employer also pays this on your behalf.
  • But when you own your business, you are essentially the employer and employee, so you pay both shares.

How much is the self-employment tax?

  • 15.3% up to the first $147,000 and 2.9% after that.
  • So the SE tax on $100,000 of income is $15,300 plus your normal income tax.
  • So as you can probably tell, people are looking for ways to reduce this amount.

Is that where s-corporations come in?

  • Yes, this is exactly when they come into the conversation.
  • As a sole proprietor, you do not pay yourself a wage, so all your income is subject to the SE tax as we just talked about.
  • But as an s-corporation, you only pay the “SE Tax” on any wages paid to yourself.

Can you give us an example?

  • Using an example of $100,000 of income, your self-employment tax would be $15,300.
  • But if you were a corporation and paid yourself a salary of $75,000 you would only pay the “SE Tax” of $11,475 or a savings of about $3,800.
  • The income tax paid under either entity would remain the same, so the savings is only from the SE Tax.

So why don’t all businesses become s-corporations?

  • Complexity mostly
  • Need to file a separate return
  • Need to do payroll including filing quarterly reports and year-end W-2
  • The savings in many instances is eaten up by administrative costs which is why $100,000 of net income is usually the time to look into this entity change

Be sure to talk to a tax professional if you have any questions about S-Corporations.

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Jeff Dvorachek
I joined Hawkins Ash CPAs in 1998. I am the partner-in-charge of the Manitowoc, WI, office and tax director for the firm. I have thorough experience providing tax services to individuals, commercial businesses, nonprofit entities and estates and trusts. I also provide compilation and review services. I lead the Tax Committee and am a member of the Information Technology Advisory Committee.

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