In my last post I talked about how S-Corp taxation classification works and how it might apply to an LLC. Now let’s take a closer look at S-Corp taxation and how it could save your business money.
S-Corp refers to a tax classification that corporations and LLCs can opt to use instead of being taxed as C-Corp, partnership or single member/disregarded entity. It comes with some unique financial benefits that lead to greater savings for those who qualify.
Pay Less in Taxes
Let’s start by reviewing how S-Corp taxation works where your income is involved. If an LLC is taxed as a single member/disregarded entity, then the full earnings of that LLC are taxed as personal income to its member and Medicare and social security taxes would need to be paid on all profits. However, if that same LLC opted to be classified as an S-Corp, its member must be paid a reasonable salary just as if he or she were an employee of the LLC. The member would pay taxes and other withholdings on the salary which would then be reported to the IRS as a business expense. Any profit would be reported as pass-through income not subject to employee withholdings. Only this pass-through income is taxed by the IRS resulting in lower income tax and self-employment taxes (social security and Medicare) paid.
Pass-Through Tax Deduction
Thanks to the Tax Cuts and jobs Act, as of 2018, an individual whose annual income is less than $157,500 can opt for a 20% income tax deduction ($315,000 for taxpayers filing jointly). If your business makes more than the designated amount, then you can opt to file as an S-Corp and give yourself an income less than $157,500. In this way, you qualify for the same 20% deduction even if your business has earned much more.
Contribute More to Retirement
Your savings aren’t limited to taxes. S-Corps can set up a Solo 401k, allowing you to put more money away for retirement than you’d normally be able to.
Normally, individuals with a Roth IRA who make less than $120k a year can only contribute up to $6,000. However, S-Corps can contribute up to $18k to a Roth Solo 401k and an additional $36k to a traditional Solo 401k for a total of $54k in annual retirement savings.
It’s Easy to Do
Provided you qualify for S-Corp taxation status, becoming one is easy. All you need do is file the proper paperwork with the IRS. You’ll want to do your homework though. Make sure you earn enough in your corporation or LLC to assign yourself a reasonable salary and take advantage of the tax and retirement benefits.
Sound like something you want your business to take advantage of? Give me a shout if you’d have additional questions or need assistance.
Written by Mark Jordan