Having your own company is both thrilling and exhausting. You get to call the shots all while stressing over expenses at 1:00am. And one of those very stressful expenses includes the taxes owe from your small business.
Many small business owners maintain an LLC business structure without ever knowing the benefits of an S Corporation. Knowing about these benefits could very well provide you and your small business with greater opportunities, which includes a not-so-stressfull bill paid to the IRS.
How Does an S-Corp generally work?
Straight from the IRS site, S-corporations pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. In simpler terms, this status taxes the business and members differently. Both small businesses and corporations can apply for it, as long as they meet the criteria. In most cases, small businesses do.
Now, S-corporations differ from LLCs because of the way profits are taxed. For instance, under an LLC business structure, the owner or member cannot be an employee, and therefore, cannot receive a salary. Instead, members under an LLC receive profits. And because they receive profits, they are taxed on the entire profit. The entire profit from an LLC will typically be liable for the following taxes:
● Federal Income tax
● Payroll tax (if you have employees)
● Self employment tax
● Sales tax (if you sell taxable goods and services)
● State tax (if applicable)
So if your LLC made $100,000 in profit, it’ll be taxed all of the taxes mentioned above PLUS any annual LLC fee, which varies by state. You’re looking at about 30% minimum taxes due on your $100,000 profit.
How am I taxed under an S-corporation?
S-corporations are known for avoiding double taxation. Because of it’s structure, owners are able to classify themselves as employees, which allows them to earn a salary. And that’s where they save money.
Under an S-corporation, you’ll receive a Salary and a Distribution—a term for money that goes to the owners of the company.
As the owner, you’ll give yourself a reasonable salary. The IRS will be watching this to make sure it’s actually reasonable and not purposely a low salary in efforts to pay a little taxes as possible.
Using the example from above, let’s give yourself a $25,000 salary out of the $100,000 profit you made. With your salary, you’ll pay:
● Federal tax
● Self-employment tax
● State tax (if applicable)
After your taxes are paid, your salary amounts to $17,500.
Next, we need to tax your distributions—the money that goes to the owners. Since you took out a $25,000 salary, that leaves $75,000 to pass through to the owners. With the distributions, you’ll pay:
● Federal tax
● State tax
See the difference yet?
The difference is you don’t pay self-employment tax on everything.
As an S-Corporation, you only pay self-employment tax on your salary. As an LLC, you pay self-employment taxes on your entire profit.
As an LLC, you aren’t allowed to consider yourself as an employee, so you don’t have the ability to give yourself a salary. Instead, the IRS taxes you on all your profits. And as you can see, it can end up being a big expense.
Now of course everyone loves to save money, especially thousands of dollars worth. But there are restrictions and criteria to meet to become a S-Corp—along with other great benefits.
Talk to an experienced CPA about the restrictions and measures as well as other great benefits of having an S-corporation for you to review.
Trying to Decide?
Tax Avenger in Canton can guide you on how to classify your small business. Our team is extremely knowledgeable and well versed in local Michigan as well as Federal tax laws ensuring compliance and minimizing tax liability. Our accounting and tax preparation services will keep your business operating with efficiency while maximizing your benefits. We provide bookkeeping services and advising, payroll services, tax preparation and planning and so much more.
If you are looking for an accounting firm to help with your small business, contact us to schedule a Free Consultation!