If you have ever read an article or blog about saving taxes as an online entrepreneur, you’ve heard of the S Corp election. The main benefit of an S Corporation is potentially to save on taxes, in particular on self-employment tax (SE tax).
THIS DECISION REQUIRES CAREFUL CONSIDERATION. The transition between an LLC/Partnership to an S-Corp should not be made by everybody.
Generally, without the S Corp status, 100% of your net profits are charged a SE tax of 15.3%. But when taxed as an S Corporation, only the portion of those profits that you pay yourself as a salary get charged the SE tax.
To be compliant with one’s S Corp status the owner must pay themselves a salary via payroll and those wages must be “reasonable compensation”. The trick, then, is to pay yourself the least amount of wages so to avoid as much SE tax as possible, but yet be considered reasonable.
For example, your net profit for the year is $50,000, however your anticipated salary is $50,000. Electing S Corp status will not yield any tax savings because your net profit does not exceed your reasonable salary ($50,000 – 50,000 = 0). Since the tax savings is in the difference between your salary and net profit it would not make sense feasibly or administratively to elect S Corp status. We suggest waiting until your business shows at least $15,000 net profit on top of your salary before seeking S Corp status. So, for this example, wait until your net profit for the year is $65,000 (salary + $15,000).
This is obviously dependent on a lot of different factors. As usual, we suggest you speak directly to your tax professional before making any changes. This is not something to be done flippantly. But if you are in the right position as a business owner, it could end up saving you significantly on taxes.
CPA On Fire is an online accounting firm for online entrepreneurs. We have extensive knowledge on working with entrepreneurs who have businesses in the ecommerce, coaching, and other online business communities. If you are looking for a highly qualified and experienced accountant, let’s connect! We will show you what we can do for your business to help you grow exponentially.