The S Corp Advantage: Maximizing Your Business Profits

The S Corp Advantage: Maximizing Your Business Profits

August 26, 2024

A lot of sole proprietors and single member LLC (SMLLC) owners are advised to elect S Corporation status due to tax savings. This advice, however, doesn’t always come with an explanation of why this change can be beneficial. Guess what? It’s not income tax savings!

Among other types of taxes, business owners pay payroll/self-employment taxes and income taxes. Payroll taxes consist of Social Security (12.4%) and Medicare (2.9%), which are typically split 50/50 between employer and employee. Sole proprietors and SMLLC owners pay both the employer and employee portions, or 15.3%, on the full amount of their business net income.

The benefit of converting to an S Corporation lies in a reduced amount of payroll tax. When an S Corporation election is made, the owner is required to pay him/herself a reasonable wage, subject to payroll tax. This reasonable wage, however, is not necessarily the full profit of the business. If a profit remains after the owner is paid a reasonable wage, it can be taken out of the business as a distribution. The distribution is not subject to payroll tax.

The chart below shows a simple calculation of how this change could save a small business owner over $6k annually: 

There are a few items to note. First, there is extra compliance required with having an S Corporation rather than a sole proprietorship or SMLLC as those entities are reported on an individual income tax return (Schedule C of Form 1040). S Corporations are required to file Form 1120S. In addition, the IRS does not define reasonable salary, so some diligence is required to ensure the wage determined is supported. Finally, an S Corporation election is generally not advised until a business is making a sizeable profit, often $100k or more annually. If these hurdles are met, however, an S Election can save the business owner a noteworthy amount of payroll tax.

For more guidance on this topic, please contact Larson & Company today.  We have developed a suite of tax services specifically to serve the needs of companies of all sizes in a wide range of industries.