When is an S Corporation Beneficial?

Why are S Corps so popular?

First, some background on single member LLCs. For tax purposes, operating as a sole owner of an LLC and operating as a sole proprietor are the same thing as the LLC is disregarded by the IRS. A single member LLC is something from the state, and that doesn't automatically dictate how the federal government/IRS sees the entity. You, the owner, make that election at a federal level to have the IRS recognize your LLC as a Corporation (either as an S Corp - where the profits pass through to you and are taxed on your individual tax return; or C Corp - where the profits stay inside the corporation and are taxed at the flat corporate tax rate of 21%) and that is what makes the LLC a taxable entity in the eyes of the IRS. 

Now, I'm sure you've heard plenty about the benefits of an S Corp - and there are some benefits, most of which arise from the fact that income from an S Corp is not considered self employment income, so you don't need to pay self employment (SE) taxes for FICA (roughly 15% on the first $168k, and then 2.9% on the remainder) on that income. However, you do need to pay yourself a reasonable wage from your S Corp, say $60,000, and that FICA tax burden is then split between the S Corp and you personally on that 60k. So, if you have a business that nets $125k of profits at the end of the year, you only pay FICA on 60k, not 125k, saving you roughly 15% on 65k - around $9,000 in SE taxes.

However, to further complicate the matter, there is a deduction for Qualified Business Income (QBID), and that removes 20% of your business income from your taxable income, and wages aren't business income, so you don't get the QBID deduction on those. So in this example, by switching to an S corp you will forgo a $13k deduction (20% x 65k), and that will increase your income taxes by about 3k (assuming that your filing jointly with your spouse), bringing your tax savings down to $6,000. 

You also need to consider the added compliance costs of running an S Corp - payroll and all the associated payroll tax returns, another income tax return, yearly meetings to keep the corporate veil, etc - that eat even further into that $6,000.

The short version of all this is - you need to be consistently netting more than $90k a year to make an S Corp worth it. You can look up S corp tax saving calculators online (this one outlines some of the caveats I mention here - https://evergreensmallbusiness.com/s-corporation-tax-savings-calculator/), but many of them only calculate the FICA tax savings and don’t show the reduced QBID deduction/increase in income taxes. 

For more information on this and how it might specifically apply to your business, please give me a call or send an email.