Find out how using these 7 strategies can save money for your business when tax season comes around.
Table of Contents
- Introduction: Overview of S-Corp Benefits
- Meet Jhoslen
- What is an S Corp?
- How Are S Corp Taxes Different From Other Tax Structures?
- 7 Smart S Corp Strategies for Your Business:
- Maintaining Your S Corp Status
- When Does An S Corp Stop Being Beneficial?
- Hire an Expert Tax Advisor to Help You Save More and Stress Less
If you own a small business, you’re probably always on the lookout for opportunities to save on taxes.
One of the ways to accomplish this is by electing S Corp taxation status with the IRS if it makes sense for your business. (Consult a CPA like me to learn more about your specific situation.)
Being an S Corp can be beneficial from a tax perspective for a few reasons:
- Reduce payroll taxes.
As an S Corp business owner, you are considered both an employee and a shareholder. As an employee, you earn a salary as compensation for your work. As a shareholder, you are entitled to receive distributions from your business profits.Your salary is subject to 15.3% in FICA taxes (social security + Medicare) on income up to $110,100. Once you pass that number, you’ll just pay Medicare tax at 2.9%.Distributions are taxed at your ordinary income tax rates.The key to reducing your payroll taxes is paying yourself a reasonable salary that isn’t too low for the field you’re in. (The IRS uses several factors to determine the definition of a “reasonable salary,” but a good way to get a ballpark figure is to find out what similar jobs in your geographic area are paying.)Once you know that number, pay yourself a salary that is equivalent to or slightly less than the local standard. Taking the rest of your profits as distributions will save thousands of dollars in payroll taxes!
- Avoid double taxation.
An S Corp is designed to enable business profits to “pass through” to company shareholders. The shareholders then pay taxes on their income via their personal tax return.A C Corporation pays tax on its company income. The remaining profits are then paid out to shareholders, who then report the income on their personal tax returns, effectively causing “double taxation.”(Keep in mind that there are some situations in which electing S Corp status is not ideal. Contact me for more information on how to choose the best business structure and tax election for your business!) (Link to contact info)
I’m going to explain all of these benefits and tell you all about my 7 Smart S Corp Tax Strategies below.
But first, let me introduce myself.
My name is Jhoslen Muniz. I’m a professional tax advisor with 20 + years of experience in financial planning, budgeting, and analysis for Fortune 500 and mid-size companies. I’m passionate about helping clients build legacies while honoring their values.
I love empowering small business owners by showing them how to understand and navigate their finances in plain English and how to keep more money in their pockets with a winning tax strategy year after year.
Do you want to learn more about how working with me can free up more cash so you can pursue the life you’ve been dreaming of?
Now that we’ve formally met, let’s dive in!
I’m going to help you understand what makes the S Corp tax designation different from other business structures AND show you seven of my winning S Corp strategies you can use to keep more money where it belongs—in your business.
The IRS defines S Corporations (AKA “S Corps”) as “corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.”
What does this mean in non-legalese?
An S Corp is a tax designation that passes a corporation’s profits through to the owner’s personal tax return.
In the United States, the federal tax filing requirements vary depending on the type of business entity. New businesses in the U.S. must choose what type of business entity you want to establish.
Your business entity determines how the business should be registered, along with what tax rates you will pay and the paperwork that must be filed with the government. It’s important to choose the business entity that makes the most sense for your business to maximize your tax savings.
Here are the most common types of business in the U.S.:
- Sole proprietorship (no LLC)
- Single-member LLC
- General or Limited Partnership (no LLC)
- Multi-member LLC
- C corporation.
(We’ll also discuss the S Corporation, which is a tax status and therefore slightly different from the five business types listed above.)
I’ll break each structure down in detail below, but here’s a quick tldr:
A sole proprietorship is the natural structure of a business if the proprietor doesn’t formally create the business with the government. Basically if you have a business on your own, but don’t file any official documentation for the business, it’s a sole proprietorship.
An LLC is a business structure that conveys legal protection for the owner or owners of a company. It creates a legal distinction between the individual taxpayer and the business. If you own an LLC and are sued, your personal assets will be protected.
You don’t need an LLC to have a business, but you do need an LLC or to be a C Corp to get the benefits of electing S Corp status.
Now that we’ve cleared that up, let’s look at these business structures in detail.
SOLE PROPRIETORSHIP (ONE PERSON – NO LLC)
A sole proprietorship is the most basic business structure. If you’re running a business but haven’t registered as any other type of business entity, you’re automatically categorized as a sole proprietorship for tax purposes. From a tax and legal perspective, sole proprietorships do not differentiate between the individual and the business. This means the individual running the business can be held liable for any debts and obligations to the business. And the IRS considers a sole proprietorship a disregarded entity for tax purposes.
EXAMPLE: Your Great Aunt Gloria bakes cookies and sells them out of her home kitchen. She has never filed any “official” paperwork since she’s running her business to make some cash to help with household expenses. As a self-employed sole proprietor, she is responsible for paying self-employment taxes and income taxes.
TAXES: A sole proprietorship is responsible for paying self-employment tax (Social Security and Medicare) and personal income tax.
SINGLE MEMBER LLC
By default, this structure is taxed in the same manner as a Sole Proprietorship. The income and expenses of the LLC are reported on the owner’s personal income tax return, using Schedule C. The key difference is the LLC status which offers liability protection to the LLC owner.
A single-member LLC can choose to be taxed as a C Corporation by filing IRS Form 8832 or as an S Corporation by filing Form 2553.
GENERAL OR LIMITED PARTNERSHIP (TWO OR MORE PEOPLE – NO LLC)
A partnership is similar to the sole proprietorship but for two or more people. If you’re running a business with two or more people but haven’t registered as any other type of business entity, you’re automatically categorized as a partnership for tax purposes. This business structure can be a general partnership or a limited partnership.
The first type are all general partners which have unlimited liability, meaning the partners are personally liable for the company’s debts.
The second type of partnership is similar to the first, but has one general partner and limited liability extends to the limited partners.
EXAMPLE: Your friend Charlie and Sam start doing business together creating websites. They are automatically considered general partners for legal and tax purposes. Both general partners are personally liable for the partnership’s debt.
TAXES: As a general partnership, Charlie and Sam do not pay income tax as a business. Instead, profits and losses are passed through the business to the partners, who then pay income tax on their portion of business ownership on their personal tax returns.
MULTI-MEMBER LLC (UNLIMITED MEMBERS)
As the name suggests, this business structure is an LLC with more than one owner. The major benefit of a Multi-Member LLC (Limited Liability Company) is that it protects its owners by creating a division between the business and their personal assets.
EXAMPLE: Remember your Great Aunt Gloria and her delicious cookies? To give herself liability protection, she decided to form an LLC for her business. But business is going well, so these days she’s working with a few partners to expand her business. After forming a Multi-Member LLC, not much changes except for the fact that neither she, nor her fellow LLC owners, can be held personally liable for her business’s debts – with a slight caveat. Remember that there must always be a clear separation between personal and business transactions. You must never mix the two or you muddy the financial waters, risking the possible ire of the IRS.
TAXES: The IRS considers LLC members to be self-employed. Therefore, they are responsible for paying self-employment tax (social security and Medicare) and personal income tax, similar to the sole proprietorship structure.
CORPORATION (“C CORP”, UNLIMITED OWNERS)
A corporation is a business entity that is legally different from and separately taxed from the individuals within the corporation.
There is no limit to how many owners a corporation can have.
Corporations offer strong liability protection, but creating and maintaining one is time-consuming and expensive.
EXAMPLE: Your family owns a construction company, Great Plains Builders, Inc., that does a lot of business in your state. The company’s business structure is a corporation. This structure protects your individual family members and their assets since the company exists as its own legal entity.
TAXES: As a corporation, Great Plains Builders, Inc. must pay corporate income tax on the company’s income. After paying income tax, the corporation will pay dividends to its shareholders, your family members who collectively own the business. Your family members must then pay income tax on their dividends. This “double taxation” means corporation members pay taxes on both the business income and on their personal income.
S CORPORATION (“S CORP”, MAXIMUM 100 SHAREHOLDERS)
An S Corp is slightly different from the business structures mentioned above because it is actually a tax designation designed to avoid the double taxation problem of a traditional corporation. A qualifying company can “elect” S Corp status, by submitting Form 2553 signed by all shareholders in the company. Both an LLC and a C Corporation may elect to become an S Corp.
EXAMPLE: Your friend Charlie is interested in diversifying his income, so he decides to open a fast food franchise. He forms an LLC for its liability protection and elects to become a S Corporation for the taxation benefit.
TAXES: Unlike a C Corporation which is taxed at the company level, an S Corporation passes income and taxes through to company shareholders, who then report this income on their personal tax returns. This prevents double taxation. It also provides favorable tax benefits because shareholders are not required to pay self-employment taxes on the distributions paid to them.
These tax loopholes could save you thousands.
You can deduct the cost of your salary and payroll taxes if you elect S Corp status for your company.
But here’s the catch: your salary must meet the IRS criteria for being “reasonable.” If you think that sounds somewhat vague to you, you’re not crazy – it’s super vague. This can either work for or against your favor. The best way to come up with a reasonable salary is to calculate market averages in your area for similar work.
For example, a contractor who owns an S Corp might pay himself a salary of $65,000. He chose this number because a general job search on places like LinkedIn and Indeed show an average salary range of between $60-$70k.
Don’t try to cheat the IRS by paying yourself a completely unreasonable salary. If you’re bringing in $3M in shareholder distributions, but you claim a salary of $20K on your taxes, you’re setting yourself up for an audit.
There are two ways to approach health insurance premiums in an S Corp: as a sole S Corp owner or as an S Corp owner with employees.
If you’re a sole owner…
Sole Owner – deduct insurance out of business and include in W-2 – $60K salary – if you take that you pay 15.3%. Health insurance is included in salary calculation. You pay 10K for year on health insurance. You only have to pay 15.3% on 50K. You have to take it out of company – SEE ARTICLE – mention just S Corp owner and if you have employees
Hiring your minor children for your business is another strategy that can help you save money on your taxes. But there are a few stipulations to keep in mind.
First, make sure you’re adhering to your state’s laws regarding workman’s comp and how many hours they are legally permitted to work per week.
Second, you have to treat your children the same as you treat any other employees, including things like sick pay and paid time off.
And third, the work being performed must be considered ordinary and necessary for your business..and must be realistic.
Hiring your 16 year old daughter to manage your social media accounts? Perfectly acceptable since maintaining a social media presence is an important aspect of running a business.
How about hiring your 12 year old to keep your books?
You might find this scenario difficult to pass the “sniff test” should the IRS come knocking.
This strategy requires care, but if correctly utilized, it can be an excellent way to combine travel with a business deduction.
But first, remember this: simply doing a little work or meeting with a client for dinner while on vacation does NOT qualify as a business deduction. If you’re trying to deduct travel, the bulk of your time away must be spent engaging directly in business activities.
However, you can make this work to your advantage!
Imagine you travel to New York City to attend a 3-day conference in your field. Most of your time is spent at the conference attending seminars and walking the trade show. But each evening you spend a couple of hours doing some sightseeing around the city. Because the bulk of your time in this scenario is spent on work and the sightseeing aspect is secondary, you would be free to deduct your travel and lodging expenses.
IRC Section 280A (AKA “the Augusta Rule”) allows an individual to rent his or her home to an S Corporation for 14 days or less during the year. The space can’t be your home office – it must be the other areas in your home. The rental amount must also reflect average rental prices for a similar space in your geographic area.
Say local rental spaces in your area rent for an average of $400-$600 per day. Using the Augusta Rule, you can charge your business $500 per day in rent to use your home. You could then claim a $7,000 business deduction through your S Corp. This is a great way to host business events and meetings in the comfort of your home while also taking advantage of a valuable tax deduction.
Another great tax planning strategy to reduce taxable income + create tax-free income (even better!) is to leverage retirement funds.
Although the specifics will change depending on your unique situation (i.e. whether or not you have employees), here are a few general strategies to keep in mind.
- HSA: If you have a high deductible insurance plan, you can deduct money paid into a Health Savings Account.The definition of “high deductible plan” changes from year to year, but in 2022 the IRS defined this as any plan with a deductible of at least $1,400 for an individual or $2,800 for a family. You can even invest the money you don’t spend on medical expenses into the stock market!An HSA works just like a Roth IRA in that the money grows tax free and can be taken out with no taxes once you reach the age of 65.
- SEP IRA: You can fund a SEP IRA with up to $66,000 of your earned income, or 25% of your annual compensation, whichever number is lower. The catch is that you must offer the same contribution percentage to any employees you have. Your SEP IRA contributions can then be deducted from your overall business income.
- Solo 401K: You can fund your 401K both as an employer and employee. The income contributed from your business will be tax deductible and your earnings will grow tax deferred until you withdrawal your money.You can also fund your Solo 401K using income reported on your W-2. The 2023 maximum contribution is $22,500.
- Traditional IRA: Although contributions cannot come from your S Corp, a Traditional IRA is still a helpful investment vehicle due to the permitted deduction from your taxable income. You’ll pay taxes at your on the funds at your current tax rate at the time of withdrawal.
- Roth IRA: Like the Traditional IRA, contributions to a Roth IRA cannot come directly from your S Corp. But if you expect to be in a higher tax bracket when you retire, the Roth IRA can be a good investment choice since taxes are paid up front. This means you’ll be able to withdrawal your money tax-free when you retire.
In the hunt for under utilized tax reduction strategies, don’t forget the most basic one of all – your basic business expenses.
As s-corp owner, deductions you can take advantage of include office space rent and supplies, business travel, insurance, technology like your work phone, computer, or tablet, and any services you utilize such as accountants, lawyers, or consultants.
Make sure to always keep your business and personal expenses separate. This will streamline taxes and accounting and ensures your liability protection is secure.
Once S Corp status is elected, you’ll need to meet specific criteria to maintain your S Corp.
You’ll need to keep your books up to date, run a regular payroll with a reasonable salary for yourself, file the correct tax return by March 15th, and make quarterly tax payments.
- A corporate must meet the following requirement to qualify as an S Corp:
- Be a U.S.-based (domestic) corporation.
- Have no more than 100 shareholders who are individual U.S. citizens and/or trusts, estates, and certain tax-exempt organizations and retirement plans.
- Have only one class of stock which confers equal ownership rights to each stockholder.
- Not be an ineligible corporation, which includes financial institutions (per the IRS, this includes certain financial institutions, insurance companies, and domestic international sales corporations).
- If a shareholder is foreign = no S corp
- Different types of stock
If a corporation is unable to meet these criteria, it should request an S Corp revocation by submitting a statement of revocation to the IRS.
When A Company Grows…
A growing company may wish to become a C Corporation if seeking outside investors. This is because financing is generally easier to obtain for a C Corp since investors prefer the structure over an S Corp or LLC.
A C Corp allows freely transferable shares, which means shareholders can buy and sell corporate shares without permission from anyone else. This flexibility is appealing to investors.
Another reason investors prefer working with C Corps is because a corporation can issue preferred stock, a type of stock that prioritizes the preferred stockholder over other stockholders. Preferred stock is an attractive benefit for investors who are usually risking personal capital to grow a business.
Conversely, if your business shrinks and your income drops below $70,000 or so, revoking S Corp status would make sense since the cost of maintaining the S Corp would negate any financial benefits. (Cant be an s corp for 5 years)
Looking for a tax advisor who will streamline your business taxes while reducing your overall bill from the IRS?
Set your business up for financial success by working with me!
Are you ready to save?
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