By Jason Watson (Google+)
Posted February 2, 2016
This KB article on self-employment taxes and S-Corp elections has been updated, and we have re-released our SubS.pdf tax article. Here are the links to get you started-
Comprehensive Guide to S-Corps in PDF (updated Fall of 2015)
Updated KB Summary Article on Avoiding Self Employment Taxes (updated July 15 2013)
Start of Comprehensive Guide to S-Corps in KB (first article of the series)
As a jumping off point for discussion, here are some numbers regarding avoiding self-employment taxes-
| Income | LLC SE Tax | S Corp Payroll Tax |
Delta | % Savings |
| $30,000 | $3,685 | $2,295 | $1,390 | 4.6% |
| $50,000 | $6,141 | $3,825 | $2,316 | 4.6% |
| $75,000 | $9,212 | $5,738 | $3,475 | 4.6% |
| $100,000 | $12,283 | $7,650 | $4,633 | 4.6% |
| $150,000 | $15,468 | $11,475 | $3,993 | 2.7% |
| $200,000 | $16,807 | $15,300 | $1,507 | 0.8% |
Note– the savings could actually creep up to 6% or even 7% by having the S-Corp pay for your health insurance, health savings account or health reimbursement arrangement. Details to follow in our S-Corp tax article (see link above).
Please click on one of the links above to take you to the newly updated KB articles on reducing self-employment taxes and electing S-Corp status. Better freshen up that coffee.. or, if it’s after 5 o’clock, freshen up that adult beverage and read on!
Thanks!
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A common complaint from those who own their own business is self-employment tax. Can you avoid it? Yes, to a large extent actually but it takes some effort.
If you own a business as a garden variety single-member (one owner) LLC, your business income will be reported on your personal tax return under Schedule C and is subject to self-employment tax (currently 15.3%) and income tax. The same is true for a business that has not formed a corporation. So, you could easily pay an average of 30% (15.3% + 15%) on all your net business income in Federal taxes. Wow!
An LLC that has multiple members (more than one owner) must file a corporate tax return on Form 1065. The income earned still flows onto your personal tax return and is subjected to self-employment taxes plus income taxes.
However, if you own an LLC and have elected to be treated as an S-Corp (Sub-S) for taxation, the business now files a corporate tax return on Form 1120S. What’s the big deal? you say.
The S-Corp election of your LLC changes how the K-1 is handled on your personal tax return. A K-1 is a statement that each owner receives, and it is similar to a W-2 since it reports the income that each owner is responsible for from a taxation perspective.
LLCs who file a corporate tax return without the S-Corp election generate a K-1 which commonly contains an amount in Box 14. This amount is the income subjected to self-employment tax. As a side note, an LLC that owns rental properties will generally not have an amount in Box 14 since rental income is passive, and not subjected to self-employment tax.
A K-1 generated from Form 1120S (LLC or C-Corp, either with the S-Corp election) flows onto the owner’s personal tax return on Schedule E. Schedule E is the form used for rental properties, royalties and other investment income including business income from an S-Corp LLC or an LLC which owns rental properties . Since the K-1 is generated from Form 1120S you only pay income tax on the business profits. That’s the good news. Here’s the not-as-good news-
An S-Corp LLC must prepare and file a corporate tax return on Form 1120S. And, it must perform payroll and pay each owner a reasonable salary. What is a reasonable salary? Good question- each situation is uniquely different, and more discussion is generally required but a good jumping off point is about 50% of overall profits. Also, remember that health benefits may be deemed compensation and contribute to “reasonable salary” tests. More on salary in a bit.
Please contact us if you want to explore this further. In the meantime here are some things to think about-
Hard Money Facts
At $100,000 in net income an S-Corp LLC will generally save over $6,300 in overall taxes with the owners in a 15% ordinary income tax bracket, and over $15,500 at a 25% tax bracket. Please see the last page of our S-Corp tax article for a spreadsheet showing these examples. You can download it at-
In creating the spreadsheet, we made a list of constants. Currently, self-employment tax is 15.3%, and FICA / Medicare for payroll taxes are combined to be 15.3%. Our tax preparation fee for a single member LLC is included with your personal tax return, so the amount is $0. Our flat rate tax preparation fee for most LLCs electing to be treated as an S-Corp for taxation purposes is $375. Please visit our website and click on Fee Structure to see our simple fees.
Our quarterly payroll service is $100. If you do not require any other payroll service except for yourself as the owner, quarterly salary payments is our suggestion. You can still take shareholder distributions as often as you like for monthly bills and expenses. We also perform a variety of payroll frequencies if your company needs it.
As you can see, $10,000 in profit is a relatively low break-even point. In other words, any amount of profit above $10,000 at an ordinary income tax rate of 15% will save you money if you elect the S-Corp taxation treatment of your business. Nice. What’s the catch?
Downside to S-Corp Election
Not everything that glitters is gold. There are a few manageable downsides to the S-Corp election. First, paying owners through payroll and filing a corporate tax return costs money- but with the example above, the savings will likely exceed the costs. And since the cost of payroll services and corporate tax return preparation is relatively fixed, the more profit you earn the more you’ll save. Something to discuss and consider.
Second, S-Corp shareholders are distributed profits as a percentage of ownership whereas garden variety LLCs use an operating agreement. This can create headaches for silent partner situations and other non-traditional ownership structures.
Lastly, if you believe social security will remain funded by the time you retire, you might be short-changing yourself since your salary will be used to gauge future retirement benefits. Remember, owner distributions not subjected to self-employment taxes will not count towards your social security benefits basis. There are some other retirement hiccups that could affect your decision, and since they are very specific and detailed, more discussion is required. Keep in mind that the tax money you save today can make excellent retirement investments.
As a side note, it is NOT a good idea to make an S-Corp election on your LLC if it owns rental property. Rental property by definition is passive income (unless you are a real estate professional) and therefore not subject to self-employment tax. But if you run your rentals through an S-Corp LLC, you will be required to perform payroll which means you’ll be paying FICA and Medicare taxes which are the same as self-employment tax. Don’t do it.
Reasonable Salary, Payroll
This is the million dollar question. The IRS through Fact Sheet 2008-25 released a laundry list of factors used in determining a reasonable salary. It doesn’t offer a lot of help. A jumping off point is 50% of net profits. Keep in mind that other employee salaries, 401k contributions, putting your kids on the payroll, taking money out through expense reimbursements and paying down shareholder loans all go into the mix too. And if you are one-person show, all you need is quarterly payroll (4 per year- super simple).
Please read our tax article on the benefits of the S-Corp election including much more on reasonable salary, and how to reduce your company company profits without reducing your takehome money at-
How Do I Convert My LLC to an S-Corp? Can I do it for 2012?
First you must be eligible- your corporation must be domestic, have 100 or fewer shareholders, have owners who are individuals, estates or exempt organizations, and have not have any resident alien shareholders. There some other devils in the details, but 99% of the LLCs out there qualify.
Second, Form 2553 (the S-Corp election form) must be filed with the IRS. It is typically due during the current tax year, however, there is relief for the late filing of Form 2553 and we can guide you through that. There is also a strong possibility that we can make the S-Corp election retroactive for 2012. It takes some effort. It requires some discussion.
Generally speaking, to obtain relief with a late S-Corp election, we prepare and file Form 1120S (corporate tax return) and attach Form 2553 to it. The S-Corp tax return cannot be accepted until Form 2553 is processed and approved. Of course we can take care of all this paperwork for you!
Costs
A corporate tax return for S-Corps on Form 1120S starts at $375 with a not-to-exceed fee of $775. The range depends on how much bookkeeping is required (help us help you). Having said that, most S-Corp tax returns are prepared for $375 which includes state, eFile and generating K-1s. Check out our Corporate Fee Structure at-
wcginc.com/images/pdf_up/FeeStructure-Corporate.pdf
As far as actually writing paychecks, we offer bookkeeping and payroll services. Depending on your state, we might kindly ask you to contact a third party provider such as SurePayroll (www.surepayroll.com). Here is a summary of our services and fees-
| Quarterly | Monthly | |
| Bookkeeping Only | $200 | $100 |
| Payroll Only | $100 | $75 |
| Bookkeeping and Payroll | $250 | $150 |
These fees will cover most situations. However, depending on the number of transactions, accounts and employees, these fees might have to be adjusted.
Unless you have other employee, we suggest owners to pay a reasonable salary to themselves quarterly, for a total of four pay checks per year. This will coincide with your estimated tax payments on your K-1 income. Remember, you can write checks directly to yourself as often as necessary throughout the quarter. These are considered owner distributions.