What is an S-Corp
An LLC is the most common type of business entity for new small businesses. It provides an extra layer of liability protection compared to being a Sole Proprietor. Unfortunately, in the eyes of the IRS, the two entity types are the same so there are no direct tax advantages. Whether you are a Sole Proprietor or an LLC, in addition to paying income taxes based on your business income, owners must also pay self-employment tax (for Social Security and Medicare) on their income from the business.
But there is a way for an LLC to pay less in taxes! It’s called an S Corp Election.
An S Corp is a small business corporation, and by electing to have your LLC taxed as one, it allows the owner (also referred to as a shareholder) to avoid paying self-employment tax because S Corp owners aren't considered to be self-employed. You will now be an employee of the company and be paid through a traditional payroll system (in additional to taking reasonable distributions).
Here’s an example of how this works:
Katie is the owner of a photography business which generates $100,000 in profit. She formed an LLC to operate the business and has now elected to have it taxed as an S Corporation. Her annual salary as an employee of the LLC is $40,000, and the remaining $60,000 of the business’s profits are passed through the S Corp and reported as profit on Katie’s personal income tax return, not as employee salary. Because this $60,000 profit is not viewed as employee wages, neither Katie nor her company needs to pay Social Security or Medicare tax on this amount, which equals big savings!
S Corp Employment Taxes: $40,000 x 15.3% = $6,120
LLC Employment Taxes: $100,000 x 15.3% = $15,300
SAVINGS: $9,180!
Katie will still need to pay income tax on the S Corp profit of $60,000, in addition to the employment taxes, but regardless, her overall tax savings is significant.
An S Corp election may not be right for all businesses, so if you would like to learn more about all the advantages and disadvantages, click here to set up a free consultation with us. We love helping small businesses!