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One of the largest expenses that every business has is taxes. If you happen to own a business, were thinking about starting one, and/or are interested in understanding ways to minimize taxes from a business perspective, this post is for you. Structuring your business as an S-Corporation (S-Corp) offers numerous benefits, including significant savings on payroll taxes. In this blog post, we’ll delve into how choosing an S-Corp structure can help you save on payroll taxes and ultimately boost your bottom line.
Note – The definitions of the technical terms in any of our posts can be found in the glossary section of our website.
Understanding S-Corps
Selecting the right business structure is vital for reducing your tax burden, and opting for an S Corp can be a smart move for small and mid-sized businesses. One key advantage of an S-Corp is its pass-through taxation system, where the company’s profits and losses flow directly to the shareholders’ personal tax returns. This setup sidesteps the issue of double taxation found in C-Corps, where both the business and shareholders are taxed on profits and dividends, respectively.
Furthermore, S -Corps allow for deductions of various business expenses, including salaries, wages, and bonuses, leading to potential tax savings. Additionally, thanks to the Tax Cuts and Jobs Act of 2017, S-Corps may qualify for a 20% deduction on eligible business income. These tax perks make S-Corps an appealing choice for small business owners seeking to trim their tax bills.
The Advantages of S-Corps and Payroll Taxes
One of the primary reasons small business owners choose to structure their business as an S-Corp is the potential for significant payroll tax savings. Here’s how it works:
Reasonable Compensation: As an S-Corp shareholder-employee, you must pay yourself a “reasonable” salary for the work you perform for the company. This salary is subject to payroll taxes such as Social Security and Medicare, just like any other employee’s wages. However, any income you receive beyond this reasonable salary is considered a distribution of profits and is not subject to self-employment taxes.
Lower Self-Employment Taxes: Self-employment taxes consist of Social Security and Medicare taxes that self-employed individuals must pay. These taxes can be substantial, as self-employed individuals are responsible for both the employer and employee portions of these taxes, totaling 15.3% of net earnings (up to a certain income threshold).
By structuring your business as an S-Corp and paying yourself a reasonable salary, you can potentially reduce your self-employment tax liability. Unlike sole proprietors or partners in a partnership, who must pay self-employment taxes on all business income, S-Corp shareholders only pay self-employment taxes on their salary, not on the distributions they receive from the company’s profits.
Example: Suppose you are the sole owner and operator of a small consulting firm structured as an S-Corp. In a given year, your business generates $150,000 in net profits. Instead of taking the entire $150,000 as salary, you determine that a reasonable salary for your role and responsibilities is $80,000. You pay yourself this amount as salary, which is subject to payroll taxes.
The remaining $70,000 is distributed to you as profits, which are not subject to self-employment taxes. By doing this, you save on the 15.3% self-employment tax (12.4% for Social Security and 2.9% for Medicare) on the $70,000 distribution, resulting in significant tax savings.
Considerations
While structuring your business as an S-Corp offers numerous tax advantages, it may not be the best option for every situation. Here are some scenarios where choosing an S-Corp structure might not be advisable:
State Tax Considerations: While S-Corps offer significant federal tax benefits, the tax treatment at the state level varies. Some states impose additional taxes or have different regulations for S-Corps, which could offset the federal tax savings. It’s essential to consider state tax implications before electing S-Corp status.
Inflexibility in Profit Distribution: S-Corps have strict rules governing the allocation of profits and losses among shareholders. Unlike partnerships, where profit distribution can be more flexible, S-Corps must distribute profits based on each shareholder’s ownership percentage. If you require more flexibility in profit allocation, another business structure might be more suitable.
Intended Public Offering: If your long-term goal is to take your company public or attract significant venture capital investment, an S-Corp may not be the ideal choice. C-Corporations are typically preferred for companies seeking to raise capital through public offerings or attract institutional investors due to their more flexible ownership and corporate governance structures.
Conclusion
Ultimately, the decision to structure your business as an S-Corp should be based on a careful assessment of your specific circumstances, including your business goals, ownership structure, profitability, and tax considerations. Consulting with a qualified accountant or tax advisor can help you weigh the pros and cons and determine the most suitable business structure for your needs.
If you have any questions regarding the terms and concepts in this post or previous ones, please reach out to either me (tedi.nati@jpacq.com) or someone on our team so we can help explain further. If you’re interested in investing with us at JP Acquisitions, you can contact us via our contact form, by emailing a member of our team, messaging us on LinkedIn, or signing up for our investor portal to set up a meeting.
As always, I hope you enjoyed reading this post as much as I have writing it. Best of luck!
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About the Author
Tedi Nati is the Managing Partner of JP Acquisitions. In his role he is responsible for broker outreach, establishing deal flow, underwriting, marketing, investor relations, and assisting in the closing process. In addition to his role at JP Acquisitions, he is an Assistant Equity Underwriter at Cinnaire, a non-profit Community Development Financial Institution (CFDI). In his role at Cinnaire, he is responsible for assisting the underwriting team in evaluating and structuring real estate equity investments and assessing the risks and mitigants associated with such. Tedi earned his Bachelor of Science in Finance from DePaul University, where he graduated Summa Cum Laude. In his free time he enjoys reading, looking for multifamily deals, and working out.
Make sure to always do your own research before making any final decisions on buying/investing real estate, stocks, or other securities. I am not a CPA, attorney, insurance, or financial adviser and the information in this blog post shall not be construed as tax, legal, insurance, construction, engineering, health and safety, electrical or financial advice. If stocks or companies are mentioned, I sometimes have an ownership interest in them – DO NOT make buying or selling decisions based on my posts alone. If you need such advice, please contact a qualified CPA, attorney, insurance agent, contractor/electrician/engineer/etc. or financial adviser.
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