By Jason Watson
This KB article is outdated. Please refer to our complete Taxpayer’s Comprehensive Guide to LLCs and S Corps at-
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To get to the net-net, we prepared fictitious tax returns to get exact numbers. At $75,000 in net income an S-Corp will generally save about $3,475 in self-employment taxes. If you use WCG (formerly Watson CPA Group) for your payroll and corporate tax preparation needs, our fee will generally be about $1,200 (give or take $200 depending on your unique situation). So some of the $3,475 is lost in additional accounting expenses but you could easily save $2,200 after it is all said and done, and the extra effort is minimal.
At $100,000 you could still net out a $3,400 savings. Not bad.
Note– the savings could actually creep up to 6% or even 7% by having the S-Corp pay for your health insurance or ealth savings account (HSA). Details in other KB articles.
The savings between an LLC and an S-Corp LLC drops off at some point because what is paid as a reasonable salary is equal to or greater than the Social Security cap. For example, if your LLC earns $250,000 your Social Security contribution limit will have been reached at $117,000 for 2014. For example, if your LLC becomes an S-Corp, your reasonable salary at 50% (or $125,000) will also meet the limit.
However, you don’t pay Medicare taxes on investment income that is under the high income thresholds (over $250,000 as married filing joint taxpayers or $200,000 as a single taxpayer). However, once you trigger the high income threshold for Medicare taxes, then you pay 3.8% (an additional 0.9%) in Medicare taxes. The tax is calculated by multiplying the 3.8% tax rate by the lower of the following two amounts:
- net investment income for the year; or
- modified adjusted gross income over a certain threshold amount.
The IRS defines net investment income for the purposes of calculating the unearned income Medicare contribution tax includes interest, dividends, capital gains, annuities, royalties, rents, and pass-through income from an passive business such as S-Corps and partnerships.
So there is some Medicare savings at higher incomes, but income too high will actually cause you to pay Medicare tax on once-safe K-1 income from your S-Corp. A parabolic balancing act for sure.