Posted in Payroll | by: Andi Smiles

This Spreadsheet Could Help You Save Over $5,000 in Taxes

We partnered with small business financial consultant Andi Smiles to help our readers build a healthier relationship with their money. Ask Andi your deepest, darkest money questions here in her Facebook group.

 

When it comes to legal structures for small businesses, S corps are the hot new kids on the block. Thanks to the 2018 tax reform, people are scrambling to start S corps because of the potential tax savings this business type may offer.

They’re sort of like that dreamy transfer student you’re too shy to talk to in the hallway. They’re popular, undeniably cool—and really intimidating.

The first thing you should know about S corps is that they ARE really cool—but not too cool for you. The second? They’re popular for a reason. Converting your business to an S corp—or starting an S corp—can save you some serious bucks on your taxes.

Yep, there’s more to this hot transfer student than meets the eye.

 

How Starting an S Corp Could Lower Your Taxes by $5,000 | Tax Savings Calculator

S corps, defined.

As an owner of an S corp, you receive something called limited liability protection. This means you’re not personally responsible for any debts or liabilities for the business since it’s separate from you as a person. This protects your personal assets if your company is ever sued.

S corps are considered pass-through entities, which means that your business doesn’t pay taxes on the profits you earn—you, the owner do. Unlike C corps, where both the business and owners pay income taxes, an S corp avoids double taxation as a pass-through entity.

Entity Type
Owner Pays Taxes
Business Pays Taxes
Sole proprietorship x
LLC x
Partnership x
S corp x
C corp x x

The catch? S corp owners are required to pay themselves a “reasonable salary” as employees and that salary is subject to payroll taxes (more on this below). S corp owners must also pay taxes on the company profits.

For the purpose of this article, we’re going to focus on single-owner S corps.

2 ways starting an S corp can help you save money on taxes.

1. It lets you write off your salary, which lowers your payroll taxes.

Per the IRS, S corp owners are required to pay themselves a “reasonable salary” as an employee of their company. Being paid as an employee means that your wages are subject to FICA payroll tax withholdings (Social Security and Medicare, among other things) AND the S corp must also pay employer payroll taxes.

You’re probably thinking, “I thought you said I was going to save money on taxes—not pay more!” Bear with me.

When you’re paid a salary via payroll, two very cool things happen:

  • Your taxes are taken directly out of your paycheck. Instead of getting a giant tax bill at the end of the year, your taxes are deducted every time you get paid. Plus, instead of footing the entire tax bill all at once, your S corp pays for half of your FICA payroll taxes throughout the year, making your year-end taxes way easier to manage.
  • Your employee payroll taxes and wages are a deduction for the company. Your salary is a write-off for the corporation → which lowers your overall profits → which lowers your taxes. That’s because you’re taxed on those profits, so when they’re lower, you pay less.
Recap:

– When you pay yourself a salary from your S corp, the personal you gets paid.

– Your income and payroll taxes are deducted directly from your paycheck. (So you don’t have to worry about having enough money to pay them off later.)

– Your S corp writes off your salary and it’s portion of your payroll taxes, which reduces your year-end taxable profits.

Now that you’re stoked on getting a paycheck from your business, let’s talk about how you get taxed on the profits from your S corp.

2. Your profits are not taxed as self-employment income.

Here’s the deal—S corp profits are NOT taxed as self-employment income.

Say what?!

I know. If you’ve ever been a sole proprietor or single-member LLC, your jaw is on the floor right now. But it’s true. Say goodbye to 15.3 percent self-employment tax on your profits! Instead, you only pay payroll taxes on the salary you earn from your S corp.

Let’s look at some numbers to see how this works. Say you earn $150,000 in revenue as the owner of a consulting firm. Here’s how your taxes stack up as a sole prop vs. an S corp.

 

These calculations are for illustrative purposes only in order to show you how two general scenarios differ. For simplicity, this example does not include the 20% deduction for “Qualified Business Income” that became available to owners of pass-through businesses under the Tax Cuts and Jobs Act in 2018. Always consult a tax professional about how changes might affect your particular tax situation.

Sole prop.

Total Revenue + $150,000
Business Expenses – $50,000
Net Income + $100,000
Taxable Personal Income $100,000
Self-Employment Tax 15.3%
Total Self-Employment Tax $15,300
How we did the math.
  • Income subject to SE tax: $92,350 = ($100,000 – (0.5*15.3%))
  • SE tax: $92,350*15.3% = $14,129.55 —> This goes on line 57, Form 1040
  • Deductible portion of SE Tax: $14,129.55*0.5 = $7,064.78 —> This goes on line 27, Form 1040
  • Adjusted Gross Income (AGI) = $92,935 (100,000 – $7,065)
  • Standard deduction: $12,000
  • Taxable income: $80,935
  • Tax: $13,745.20
  • Total tax: SE Tax + Income Tax = $27,874.75
  • After tax income: $100,000 – $27,874.75 = $72,125.25

S corp.

Total Revenue + $150,000
Business Expenses – $50,000
Salary – $50,000
Payroll Taxes Paid by Corporation (FICA and FUTA) – $4,259
S corp Net Income + $45,741
Payroll taxes paid by individual $3,825
Taxable Personal Income (Salary + Profits) $95,741
How we did the math.
  • Adjusted Gross Income (AGI) = $95,741 ($50k [wages] + $45,741 [S Corp net income])
  • Standard deduction: $12,000
  • Taxable income: $83,741
  • Tax: $14,387.34
  • Total tax: Payroll Tax + Income Tax = $22,471.34
  • After tax income: $95,741 (AGI) – $22,471.34 (Total tax) = $73,269.66

What’s the tax savings between these two scenarios? $27,874.75 – $22,471.34 = $5,403.41!

Notice how in the second scenario, the S corp owner’s after-tax income is higher? That means they’ll pay less in taxes while earning more. Whoa!

So, should you start an S corp?

Looking at these numbers, you might be ready to drop everything and start one. But before you do, it’s important to assess if an S corp is really for you.

First, the lower your net income, the less beneficial an S corp will be for you. Unfortunately, there’s no magic number that indicates it’s time to switch.

However, if you’re not making at least $40,000 in net profits annually, you probably won’t benefit from switching to or starting an S corp.

Here are the main drawbacks of S corps:
  • They’re more expensive and time-consuming to set up.
  • They’re more work to maintain and have additional reporting requirements than other business entities.
  • You’ll likely need to hire an accountant to calculate a reasonable salary and file your taxes.
  • You must have the cash flow to sustain regular payroll runs, payroll taxes, and payroll service fees.

For some, these drawbacks far outweigh the tax savings, while for others, the upfront costs are totally worth it to save money on an ongoing basis. It depends on your long-term goals with your business and personal finances.

A checklist + spreadsheet to help you see if an S corp is right for you.

Start by playing with the numbers.

  • What’s your annual net income?
  • How much are you currently paying in self-employment tax?
  • What is considered “reasonable compensation” for your industry and your role in the business?

Once you have those numbers, run through a few different tax scenarios to see if you would save any money.

I created this S corp tax savings calculator to give you a place to start.

 

S corp vs. Sole prop | Payroll tax savings calculator

 

As you’re running through the calculations above, be sure to talk to a financial pro to help you weigh the pros and cons. Remember, the more you learn about S corps, the easier it will be for you to decide if it’s the right entity for you.

Now take a deep breath, suck it up, and go ask that hottie to the dance.

 

The opinions expressed in this article are those of the author and do not necessarily represent Gusto’s views.

This article provides general information and shouldn’t be construed as tax advice. Since tax rules may change over time and can vary by location and industry, it’s always best to consult a CPA or tax advisor for advice specific to your business.