At a networking event, someone mentions they made an S corporation election last year and saved thousands in taxes. By the end of the night, three other owners are asking the same question: should I do that too?
The next day you see an influencer talking S corps on TikTok.
Everybody must be doing it.
It’s almost never a good idea to get tax planning advice from social media, but it’s a reasonable thing to wonder about. It’s also one of those topics that gets talked about a lot without much of it landing correctly. So here’s the plain version.
It’s a tax election, not a new business structure
LLCs and C corporations have the option of taking an S election, which is a tax election you make with the IRS that changes how your profit gets taxed.
| Without an S election | With an S election | |
| LLC | All profit counts as your personal income, and every dollar of it gets hit with self-employment tax | Profit stops being fully hit with self-employment tax. |
| C corporation | Profits get taxed once at the business level, and then taxed again if any of it is paid out to you. | Profit stops being taxed twice. |
With an S election, the profit passes through to you and gets taxed once. Then, you divide the money you move from the business’ bank account into your pocket into two parts:
- A salary, paid to you like any employee’s paycheck
- A distribution, which is everything else.
Only the salary part gets that extra tax. The distribution part doesn’t.
But there’s a catch
It sounds like free money, but it’s not quite that simple.
- You need to put yourself on payroll and pay yourself a reasonable salary. You can’t just declare that all profits are exempt from FICA.
- That salary is still subject to the same FICA rules as before: the base rate up to $184,500, plus the surtax if you’re above $200k ($250k if married). So this portion of your profit doesn’t actually escape the tax.
- On top of that, if you don’t already have employees on payroll, you’re going to have to pay a payroll company to do that for you.
- You’re also going to have to file another tax return at year-end. Not just the 1040 that you normally file, but also an 1120-S. Your tax preparer is not going to do that for free.
So is it worth it?
A good rule of thumb is that it’s not really worth the extra costs and burden if you’re making much less than $100k.
There are exceptions, of course, but using a back of the envelope example, if your profit is $75k and your reasonable salary is $50k, you’re looking at less than $2k of savings, and you’re going to use up almost all of that on payroll fees, and extra tax returns, so it just might not be worth the trouble.
As your profits get into the high-5 figures, and definitely at $100k+, the math starts to work for you, so that’s the time to get in touch with us or your tax preparer to start doing some planning.