If you are planning to open your own business you will have many things on your mind. Normally the last thing people think about is taxes. However, tax planning on the front end can give you more money in the long run. Unfortunately, many small business owners do not know this.
Want to hear more? Then read on.
Many small business owners incorporate their business; sometimes they start out as a partnership or sole proprietorship. Neither has limited liability, but people do not worry about that at the beginning, even though they should. Others choose to operate as a Limited Liability Company (LLC) and allow everything to flow through to their personal returns.
Okay, so what is the big deal?
The first point is that LLC’s can be (and often should be) taxed as S-Corporations. An S-Corp is meant for a company with less than 100 shareholders, which in essence are most small businesses and even larger businesses in the country today. Therefore, most people can choose to have their LLC taxed as an S-Corp. Normally you have to file form 2553 with the IRS to elect the S – Corp taxation.
The second point is that you could just create an S-Corp from the beginning, but often people do not like this because of the increased costs normally associated with creating one versus an LLC. It does not really matter for tax purposes since LLC’s can be taxed as S-Corps.
So now we know that starting a business as an S-Corporation is good….. but why?
The savings is in the self employment taxes that are normally assessed if not taxed as an S-Corp.
Say your company has a net profit to you of $100,000. If you are not an S-Corp, you will have to pay about 15% in self employment taxes which equates to taxes of about $15,000.
Now, in an S-Corp the owner has to take a “reasonable wage”, so let us say $40,000 is deemed that. Your tax bill will be 40,000 x 15% = $6,000. This is a tax savings of $9,000!
So, how is this possible?
The other $60,000 is deemed a distribution and not a wage; therefore the self employment taxes are not assessed. I bet you are thinking that you could call the whole $100,000 a distribution and take no wage. Not so fast my friends.
The IRS is careful to examine S – Corporations to ensure they pay a reasonable wage. Now, that varies quite a bit, so by at least being reasonable greatly reduces your chances of being audited.
Some forget this and take no wage, so guess who gets audited first?
Are there disadvantages to an S-Corp?
The main disadvantages of the S-Corps is the complexity involved could require higher fees for professional services such as a CPA or attorney. However, the savings often outweigh the additional costs.
There are many things to consider before starting your business though. It is always best to contact multiple professionals to get each perspective on the situation. A lawyer and CPA have different backgrounds and may have different advice. So be sure to fully explain you situation and hopefully you can come to a conclusion on how to proceed.
So do not forget about being taxed as an S Corp. It could save you lots of money!