How S Corporations Save Taxes

How to Save Taxes with an S Corporation

Setting up an S corp, or S corporation can save business owners taxes in roughly three ways:

S Corporation Benefit 1:

As compared to regular C corporations, S corporation owners can use the business’s losses—such as those incurred during the startup phase—on their personal returns as deductions. Note that this “S corporation advantage” is also shared by single member and multiple member limited liability companies (LLCs) electing default treatment.

EXAMPLE: A new business, organized as an S corporation, incurs $20,000 of losses in its first year. If the business is equally owned and operated by two shareholder employees, Able and Baker, Able and Baker each get a $10,000 business deduction on their individual tax returns. This $10,000 deduction might save them each as much as $4,000 in federal and state income taxes.

S Corporation Benefit 2:

As compared to almost every other business form, S corporations can save their owners self-employment or Social Security/Medicare taxes.

EXAMPLE: Able, Baker and Carter independently each own businesses that make $90,000 a year in profits. Each business owner may pay $13,000 in income taxes. But, unfortunately, that’s not the only tax they pay. Each owner also pays self-employment or Social Security/Medicare taxes.

For example, Able operates his business as an LLC and therefore pays 15.3%, or roughly $13,500, in self-employment taxes on his profits. Baker operates his business as a C corporation which pays all of its profits to him as a salary. Accordingly, Baker (through his corporation) also pays 15.3%, or roughly $13,500, in Social Security and Medicare taxes.

Carter’s situation is different. Carter operates his business as an S corporation which means that Carter can split his $90,000 of profits into two payment amounts: salary and S corporation distributions. Suppose that Carter says only $30,000 of his profits are salary. In this case, Carter pays the 15.3% Social Security/Medicare tax only on the $30,000 in salary. Carter therefore pays roughly $4,500 in Social Security/Medicare taxes—and annually saves $9,000 in taxes as compared to Able or Baker.

S Corporation Benefit 3 (which may not be much of a benefit any more…)

A final possible benefit: As compared to regular corporations, S corporations sometimes save owners taxes because S corporations don’t pay corporate income taxes. (This means that S corporations avoid the often-talked about “double-taxation” problem.) But the “no corporate income taxes” benefit often isn’t a savings for small corporations and their owners.

Suppose that two corporations each earn the same pretax profit of $100,000 and are owned by Devlin who pays the highest federal income tax rate of 35%. One corporation is an S corporation and the other is a C corporation. S corporation can distribute the entire $100,000 in profits to Devlin as dividends because there is no corporate income tax. Devlin then pays $35,000 in personal income taxes on the S corporation profits, which means she nets $65,000 in after-tax profits from S corporation. In comparison, C corporation can’t pay the entire $100,000 in profits to Devlin. C corporation first pays $22,250 in corporate income taxes. When C corporation pays the remaining $77,750 to Devlin as a dividend, Devlin pays another $11,663 in 15% “dividend” taxes on the C corporation. This means that Devlin nets roughly $66,000 in after-tax profits from C corporation. In this case, Devlin saves money with a C corporation in spite of having to pay the corporate income tax.

How to Get S Corporation Benefits:

For help assessing whether turning your LLC or regular C corporation will truly save you taxes, please email me at steve at stephenlnelson dot com or telephone me at 425-885-9499. You and I can arrange either an in-person or telephone meeting where we together estimate the benefits you’ll receive from S corporation status. I’ll also provide you with information on the requirements for electing S corporation status and the typical small business disadvantages of electing S corporation status. If you’re well-organized, this meeting should take less than an hour.

To convert your LLC or C corporation to an S corporation (assuming you decide that S corporation status makes sense), you’ll need to supply me with your previous year’s tax return if you’re operating an existing business or your SS-4 if you’re operating a new business. (The SS-4 is the form you used to get an employer identification number.) If your situation is straightforward, my work to elect S corporation status is very modest. It typically takes an hour or two of my time to help you elect S status for a new business. If you want to elect S status for an existing LLC or C corporation, the work typically takes three or four hours of my time.

Tip: Your tax savings can’t start until you elect S corporation status. If S corporation status saves you money, therefore, it’s possible that each month of delay costs you several hundred dollars in extra taxes.

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