Your Money: What’s the big deal about S Corps?
Whether you are starting a new business or making a shift in your existing business, you’ve probably heard plenty of rumors about the benefits of becoming an S Corporation. While there may be many legal benefits, or disadvantages, I’m not an expert in that area and you should discuss that with your attorney. Instead, I’m here to set the record straight from a tax standpoint.There is only one principal benefit of being an S Corporation. For the most part, you can take all the same tax deductions whether you are a sole proprietorship, an LLC, an S Corporation or a C Corporation. Any expense that is ordinary and necessary for your business operations is deductible. Sure, there are nuances between the various formations, but the bulk of the benefits from choosing an S Corporation formation stem from the different between salary and distributions. Unlike any other formation, an S Corporation has a slight advantage in the tax arena because of its ability to pay its owner/operators themselves a salary and withdraw additional profits as distributions. While the salary portion of pay is subject to both income tax and the 15.3 percent self-employment tax, the distributions withdrawn are only subject to income tax, and avoid the additional 15.3 percent self-employment tax.Knowing this, you would expect S Corporation owners to pay themselves with distributions and just skip the salaries, right? Not so fast. The IRS requires the amount of profits paid out as salary be “reasonable.” I’ve worked with some CPAs who define reasonable as 100 percent of profits, and others who define reasonable as $0. I personally encourage my clients to take a more middle-of-the-road approach and figure out their salary as either 60-75 percent of the profits, or based on what it would cost to hire a replacement for their position. So if your company earns profits of $100,000 each year and you are a professional in your field, then you should be paying at least $70,000 in wages at a minimum, perhaps more. Under this scenario, you’d still be able to save 15.3 percent of the remaining $30,000 profit you withdrew as distributions, or $4,590 in self-employment taxes.Of course there are downsides to being an S Corporation as well. There are costs involved with paying an owner a salary, over and above the self-employment tax. You must set up a payroll system (average cost of $60/month if you use an accountant or payroll service), and the tax return is a bit more complicated and more costly, than a sole proprietorship or partnership. Also, deductions that other businesses may be able to deduct in full such as the home office and mileage expense are subject to the 2 percent Unreimbursed Employee Expense limitation for S Corp owners. Because of these downsides, it is important your business has enough profits to sustain paying a reasonable salary plus have funds left over to pay large enough distributions so that your self-employment tax savings outweigh your other costs.Like any important financial decision, you should consult your attorney and accountant before taking the leap, but I bring up this topic specifically because I often hear rumors about phantom benefits of S Corporations and I hate for anyone to make the jump before it truly benefits them from a financial and legal perspective!Michele Knight, owner of Knight Accounting & Technology, is a CPA and QuickBooks ProAdvisor based in Dillon. For more info and to contact her, visit http://www.cpamichele.com.
Support Local Journalism
Support Local Journalism
As a Summit Daily News reader, you make our work possible.
Your donation will be used exclusively to support quality, local journalism.
If you don't follow the rules, your comment may be deleted.
User Legend: Moderator Trusted User