Should I organize as an S-Corp or be taxed as one? This question comes up frequently for those starting a new business or those that have had a sole proprietorship or single-member LLC for a while. While these organizations are much easier to manage in terms of legal and tax filings, you will also pay both the employee AND the employer portion of Social Security and Medicare taxes. If you were an employee of a firm (you received a W-2 at yearend), you would pay only the employee’s portion of Social Security (6.2%, on up to $118,500 of wages for 2016) and Medicare (1.45%, and no wage limit). However, as a sole proprietor or single-member LLC, you will now also pay the matching amount for the employer portion of these taxes. The only bonus here is that you can deduct the employer portion when calculating your adjusted gross income on the front of your 1040.
Here’s a quick and dirty example of when taxation as an S-Corp can be a good thing.
Sole proprietor/Single-member LLC
Net income = $100,000
Less self-employment adjustment (employer portion of taxes at 7.65%) = <$7,650>
Taxable self-employment income = $92,350
Self-employment tax (employee + employer = 15.3%) = $14,130
(Note: You may deduct one-half of the above, $7,065, from your AGI on the front of your 1040.)
Net income = $100,000, split 50/50 between salary and distribution
Social security and medicare tax, employee + employer (15.3%), on $50,000 = $7,650
(While it may be tempting to have ALL $100K taken as a distribution, the IRS regulations dictate that you take a reasonable salary.)
**Savings on Social Security + Medicare tax = $14,130 – $7,650 = $6,480
Note, also, that you may incur additional state taxes for the S-corp. For example, in California, you must pay 1.5% of net income, or minimum $800. For our example, then, the approximate savings would drop from $6,480 to $4,980.
As with everything tax related, there are some details that are not described above, but this should give a basic understanding of the taxation difference between a Schedule C business and a S-Corp business.
If you have any questions, please do not hesitate to reach out!