There’s a load of information out there about what S Corps are, and how they differ from C Corps, LLCs and all the rest. We’re not going to get bogged down in that, although if you’d like to learn more, check out our previous blog.
Our focus here is on one key question.
The answer is that it depends on your business’s size and turnover. But even if you’re running a one-person business, you don’t need to be a sole proprietor. You can form a corporation or limited liability company, have it taxed as an S Corp, and start reducing your outgoings.
The main benefit of S Corps is the opportunity for savings on self-employment tax. That means spending less on your Social Security and Medicare taxes.
S Corps are the most popular corporate structure in America. The IRS estimates that there are more than 5 million of them in the United States.
When you are self employed, you are both employee and the employer for tax purposes and end up paying twice as much federal tax as W-2 employees. Their employers match their contributions before they receive their pay check.
When you form an S Corp, you become an employee, as well as a shareholder. You have to pay yourself a reasonable salary from your profits, and that will be taxed once as an employer and once as an employee. But everything you don’t pay to yourself as a salary is not subject to self employment tax.
Business owners have to report only on the income and loss incurred by the business in their personal income tax returns. Plus, they can deduct as much as 20% of business' income while filing their personal income tax returns.
👩🏽💼Your annual profit is $100,000, so you’ll owe $15,300 in federal tax as a self employed worker.
If you form an S Corp, then pay yourself a wage of $50,000, which is a reasonable salary for your work, then the remaining $50,000 would not be subject to tax. Your tax bill would be reduced by more than 💰$7,000💰.
Another benefit is that unless your business has inventory, as an S Corp it can stick to cash basis accounting. This makes the accounting process a lot simpler.
If your business’s turnover is less than $40,000 per year, the costs will likely outweigh the savings ⚖️.
Step 1: Establish an LLC or a C Corporation
Since an S corp is not a legal business entity in itself, you will need to incorporate it as one beforehand. For this, you must file your business with your state or territory. It's best to check with an attorney or a CPA before you commit and make sure you understand the implications of paying less federal tax.
Step 2: Ensure Your Business Qualifies for the S Corp Status
The requirements are:
Step 3: File Form 2553
Once you have checked off everything from the eligibility checklist, you can now file Form 2553 signed by all the shareholders of your company. LLCs will need to file Form 8832. Your business can expect to hear back from the IRS within 60 days of filing the form.
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