The S-Corporation advantage for active businesses
The S-Corporation is an available tax election for LLCs, both single-member and multi-member, provided that they comply with the S-Corporation restrictions.
Why should I care about S-Corporation taxation?
Mainly because it lets you save potential medicare and social security taxes. Here's a simplified example:
- Your LLC earns a $100,000 profit
- And you wish to pay out that $100,000 profit
For a Disregarded Entity:
- You would withdraw $100,000 from the LLC and pay it to yourself
- You would pay income taxes on the $100,000 at your regular federal tax brackets
- You would additionally pay Self Employment tax on the $100,000 at your regular federal tax brackets
See the following table for the simplified numbers assuming this is the Owner's sole source of income for the year. Assumptions: the owner was single, had no other sources of income, took $6,300 standard deduction, took $4,000 of personal exemption, and no unemployment considerations.
| Description | Dollars |
|---|---|
| LLC's Net Profit | $100,000.00 |
| Self Employment Tax Owed | ($14,129.55) |
| Federal Income Tax Owed | ($16,450.00) |
| -------------------------- | -------------- |
| Net Taxes Owed | ($30,579.55) |
For an S-Corp
- The LLC makes a net profit of $100,000.00 before payroll expenses and deductions.
- You would pay yourself a reasonable salary of $50,000, and pay a distribution of $50,000. The distribution is slightly less after factoring in some increased expenses in order to not make it look like the business made more money.
- You would pay income taxes on the $100,000 at your regular federal tax brackets
- You would pay your share of Social Security and Medicare on the $50,000 salary only, and not the distribution. The LLC pays the employer's share of the $50,000 salary.
- The LLC gets to deduct the LLC's portion of the employer's share, reducing your net income as well.
See the following table for the simplified numbers assuming this is the Owner's sole sources of income for the year. Assumptions: the owner was single, had no other sources of income, took $6,300 standard deduction, took $4,000 of personal exemption, and no unemployment considerations.
| Description | Dollars |
|---|---|
| LLC's Net Profit before payroll | $100,000.00 |
| LLC's EmployER payroll expense (50k x 0.0765 + $50k) | ($53,825.00) |
| LLC's Net Profit after payroll | $46,175.00 |
| Total Income to be taxed for regular tax | $96,175.00 |
| EmployEE's payroll taxes (50k x 0.0765) | ($3,825.00) |
| Regular income tax owed | ($13,438.00) |
| ------------------------------------------------------ | -------------- |
| Net Taxes Owed Personally | ($17,263) |
This makes for an approximate difference in taxes in the amount of 30,579.55 minus 17,263.00 for a savings of: $13,316.55. This means if your costs of implementing payroll and complying with federal and state employment laws is less than this number (it most likely is), an S-Corporation may make great sense. Note that the numbers are always different in reality and the taxable amounts and rates change from year to year. But I hope this illustrates the substantial tax savings available with an S-Corporation.
A caveat for professionals that have high earning potential: you can't just set the salary portion of an S-Corp as low as you want; if you get audited then the IRS will argue that you should have been paying a higher salary for your position. Be sure to ask your tax professional how to set your salary versus distribution ratio for your S-Corporation.