How Tax Planning And S-Corps Can Save You Money This Year
Business owners have a lot going on. The nature of owning a business and being self employed is having many options in how you do things. Among these things is tax planning.
What is tax planning? Tax planning is the practice of arranging a business and its owners finances in such a way that the tax burdens they incur can be optimized and organized for efficiency. For example, the way many people use traditional IRA’s to save for retirement is a form (although basic) of tax planning. They take a deduction today when their marginal tax rate is higher to lower their taxes and then in the future they cash out their IRA at an older age and claim those funds as income when their marginal tax rate is low and pay their lower taxes on the money.
There are many tools and options that allow CPA’s and tax accountants to help their clients organize their taxes to lower their burden ethically. The key word here is ethically. There is a fine line between effective planning and tax evasion. It goes without saying but we highly discourage overly aggressive tax planning that could be taken for tax evasion.
However, one safe tool that can be utilized for tax planning is an S-corp. A S-corp is legally a corporation or a limited liability company that made the Subchapter S election, hence the name S-corp. Now we have to be clear here because many people get confused on this; but an S-corp is not its own type of legal entity or type of incorporation. As stated earlier it is simply a corporation or a limited liability company choosing to be treated differently for tax purposes with the IRS. So an entity can be both an LLC and an S-corp, and an S-corp does not provide special legal benefits, only certain tax benefits.
The chief among these is the ability to receive your business profits in a manner that lets you lower the amount of Social Security, Medicare, or self-employment taxes that you have to pay. With an S-corp your business profits can be split into two specific categories: wages and distributive share. Wages are the salary you pay yourself as the owner and the distributive share is the leftover amount of the profits once the wages have been removed. The key here is that self employment tax which is currently a total rate of 15.3% (12.4% Social Security plus 2.9% for Medicare) only applies to your wages. Meaning that the portion of your profits that is considered a distributive share, avoids this 15.3%.
To put this into an example: imagine there are two people who each have a business, one is a traditional LLC for tax purposes and the other is an LLC that has made the S election to be taxed as an S-corp. Imagine that these businesses each make $100,000. Person one would pay $15,300 in self employment tax ($100,000 * 15.3%). Person two only takes $50,000 as a wage for working in the S-corp and the other $50,000 of profit is a distributive share. Person two only has to pay $7,650 in self employment tax ($50,000 * 15.3%). Two companies making the same amount of money but each business owner pays drastically different amounts of tax.
This is one of the many upsides of the S-corp, and how it can help you ethically lower your tax burden. To learn how your business can benefit from an S-corp please reach out to us, we would be happy to answer any questions.