Right now, as a sole proprietor or single-member LLC, all of your net income is subject to self-employment tax (which is 15.3% for Social Security and Medicare) and income tax. However, by electing to be taxed as an S Corporation, you can take a portion of your earnings as payroll (a reasonable salary) and the remainder as profit distributions—reducing the amount subject to self-employment tax.
How Do the Tax Savings Work?
Here’s a simple breakdown:
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As an S Corp, you must pay yourself a “reasonable salary,” which is subject to payroll taxes.
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Any remaining profits can be taken as distributions, which are not subject to self-employment tax.
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This structure can lead to significant savings on Social Security and Medicare taxes while still allowing you to take home the same overall income.
Example of Potential Savings
Let’s say you earn $100,000 in net profit:
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As a sole proprietor: The entire $100,000 is subject to self-employment tax (15.3%), costing $15,300 in self-employment taxes.
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As an S Corp: If you pay yourself a reasonable salary of $50,000, only that portion is subject to payroll taxes ($7,650), and the remaining $50,000 in distributions is free from self-employment tax—saving you $7,650!
What Are the Requirements?
To take advantage of this strategy, the IRS requires that:
✅ You pay yourself a reasonable salary (based on industry standards).
✅ You process payroll through a service and file payroll tax reports.
✅ You maintain separate business finances and keep accurate records.
Costs to Consider
There are some additional costs with an S Corp, such as:
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Payroll service fees ($65/month with a one time set up fee of $250).
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Additional tax filings (a business tax return starts at $795+).
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Compliance with IRS payroll requirements. (Certus offers an IRS defensible Reasonable Compensation study, $50)
Bottom Line: Is It Worth It?
For many business owners, the tax savings far outweigh the costs. If your business is consistently earning $40,000+ in net profit, an S Corp may be a great way to reduce your tax burden.
Next Steps:
Reach out today so we can help you decide if this is right for you!
385-557-7700
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