An S-Corporation is a popular entity for tax savings, ideal for most small business owners.

Many business owners ask if an S-Corporation suits their business. The stakes are high, so it’s crucial to understand the differences between an S-Corporation and LLC.

Some advisors give poor advice, costing small business owners thousands. As a business owner, you need to understand basic concepts to evaluate professional advice.

Introduction to the S-Corporation

LLC Taxed as an S-Corporation
An LLC ‘taxed as an S-Corp’ is equivalent to a standard S-Corporation. The IRS treats them the same. Converting to an S-Corporation (using IRS Form 2553) doesn’t change your company name with the State. You’ll keep the ‘LLC’ acronym. Many start with an LLC to later ‘convert’ or ‘elect’ S-Corporation status when appropriate. This is cost-effective. Before the ‘election’, LLCs are taxed as sole proprietorships or partnerships.

Remember, an LLC doesn’t save taxes, which is why we convert to an S-Corporation.

Benefits of an S-Corporation
The main benefit is saving on Self-Employment Tax (SE Tax or FICA), which is 15.3% of your income. In sole proprietorships or LLCs taxed as such, SE tax applies to all net self-employment income. For small business owners, FICA taxes can exceed federal income taxes. The S-Corporation offers a solution, and this is why we are promoting it at our firm.

S-Corporations split income into salary and pass-through portions. As pass-through entities, they avoid corporate tax. Owners pay ordinary income tax on earnings. However, SE tax only applies to the salary, not net income. This saves $150 in taxes per $1,000 classified as pass-thru income.

Other benefits include:

• Asset protection
• Cost-effective Solo 401k contributions
• Corporate credit building
• Lower audit risk (S-Corps are 15x less likely to be audited than LLCs/Sole proprietors)

When to Use an S-Corp
Consider these 5 factors:

1. Do you have Income Subject to Self-Employment Tax?
This determines if you need an S-Corporation. Self-employment income is ‘ordinary income’ from services or product sales, not W-2 income.

2. Are There Restrictions on Operating as an S-Corporation in your Industry?
Check with local licensing boards if you’re in a licensed profession (broker, realtor, insurance agent, doctor, lawyer, contractor). Most allow S-Corporations, but some require the S-Corporation to hold the license, which can be costly and time-consuming. Assess potential tax savings against setup costs before deciding.

3. How much Income do I need Before an S-Corporation Makes Sense?
This is crucial as you don’t want to incur S-Corporation costs unless tax savings exceed them. Generally, the break-even point is around $40k in net income. If your business has net ordinary income subject to SE tax of $40k or more, consider an S-Corporation. This break-even point is based on salary/net-income allocation. We carefully tailor payroll allocations to each owner’s situation, often saving $2,000-$3,000 at this threshold.

Consult an advisor who understands this strategy and can be cautiously aggressive. For expert advice, contact our office 414-285-2446 or by visiting our website.

4. How will this Affect my 199-A Deduction?

The 199-A deduction from the Tax Cuts and Jobs Act gives small businesses a 20% deduction on pass-through income. It may phase out for professional service owners with AGI over $157,500 (single) or $315,000 (joint).

Non-professionals face similar calculations at these income levels. This deduction works well with S-Corporations, offering planning opportunities to balance salary and net income, minimizing SE tax, and maximizing the 199-A deduction.

5. How much will an S-Corporation cost me?

Setup costs range from $200 to $1,000, depending on consultation, support, and documentation. We charge $500 or $1,000, plus filing fees, for any state. Be cautious – it’s not just filing articles. Ongoing costs include maintenance, quarterly and annual tax filings, payroll, and a year-end tax return. These could range from $1,500-$2,000 annually. We strongly recommend year-round tax planning for S Corporation owners.

S-Corporation savings should exceed $2,000 to make financial sense. Consider asset protection, corporate credit, and audit risk reduction benefits too.

Conclusion

I believe S-Corporations are best for long-term operational business owners. Don’t underestimate their power. Get a second opinion if advised against it. Our tax professionals can help you decide based on these factors and more. A consultation costs less than choosing the wrong entity!