CPA Robert Russo Breaks Down the Question: Should My Business Be an S Corp?
Will it help or hurt me? The team at Robert P. Russo, CPA has been getting questions about which business entity will allow them to best take advantage of the law. One question that keeps coming up is: should my business be an S corp? We get this question from LLCs and sole proprietorships – even employees wondering if now’s the time to launch that startup.
The answer to “should my business be an S corp”? It depends. There are benefits to becoming an S corporation (taking a distribution of dividends exempt from self-employment tax). But there are also pitfalls – if you don’t follow S corp requirements (take too large a distribution, and you could hear from the IRS).
We’re clearing the 6 most common myths regarding million-dollar question: should my business be an S corp?
First, take a moment to understand the types of possible entities for your business. This quick overview of choosing a business entity offers simple definitions.
Question: Should my business be an S corp to take advantage of the new 20% deduction from the Tax Cuts and Job Act?
Answer: While an S corporation can take the 20% deduction on qualified business income (QBI for short), so can LLCs and sole proprietorships, and partnerships.
Question: I’ve heard that with an S corp business structure, you can pay yourself a small salary that’s taxable – then larger distributions that are free from FICA taxes of 15.3%.
Answer: The IRS keeps watch on S corps, ensuring that they pay themselves a “reasonable salary.” Let’s say you are a graphic designer. You form a single owner S corp and your net profits are $70,000 for the year. Nice, you think. I’ll pay myself a $10,000 salary, then take the $60,000 as dividends. Not so fast. The average graphic designer makes about $53,000 in 2023, according to Glass Door. You’ll need to pay yourself a salary that’s more than $10,000. To find the right number that gives you the tax advantages of being an S corp – but also meets the IRS guidelines – the Russo CPA team can help, contact us.
Question: Can you explain FICA taxes to me and why they are important when I’m thinking, should my business be an S corp?
Answer: FICA stands for Federal Insurance Contributions Act. FICA taxes pay for Medicare are Social Security. The tax rate is 15.3% on up to $160,200 of net income (then an additional 2.9% on any net income over $200,000-250,000). In an LLC or sole proprietorship, you must pay the full 15.3%. But in an S corp, you only pay the 15.3% on your salary – not the dividends you take. Here is how the math works out:
S Corp Total Income = $70,000
Salary is $45,000 x 15.3% = $6,885 Owed in FICA Taxes
Dividends are $35,000 x 0% = $0
LLC Total Income = $70,000
Total Income x 15.3% = $10,710 Owed in FICA Taxes
So, the S Corp delivered $3,825 in tax savings to the graphic designer.
A quick note, we’re focusing on single owner S corps. But S corps with more than one owner must take distributions at a set percentage rate for all shareholders in the company.
Question: So, I should obviously just form an S corp already, right?
Answer: When asking should my business be an S corp because of tax savings, don’t be fooled into thinking it will be a cake walk. There are strict requirements you must follow to run your S corporation – even if you are the only owner. That means corporate bylaws and minutes of shareholder meetings (yes, you will need to have meetings with yourself). This article on the QuickBooks blog provides an excellent overview of the steps to form an S-Corp.
Question: Well, I can take the extra time to meet the requirements. I think I have the answer to should my business be an S corp!
Answer: Time is one thing, but when thinking should my business be an S corp – also consider the cost. There will be legal fees in setting up your entity. And S corp accounting can be more involved than accounting for an LLC or sole proprietor. In fact, some unsavory accountants will push you towards an S corp unnecessarily just to get the extra work. That’s why at Robert P. Russo, CPA, we often work with our clients starting a new business to see if an LLC or sole proprietorship works best. Still, the potential tax savings are there – so your business may be better as an S corp structure.
Question: So, it may not be worth becoming an S corp? I’m confused.
Answer: A good CPA can help you figure this out. Every situation is unique. You can perform Google searches on “should my business be an S corp” all day long. But there’s no substitute for sitting down with a CPA firm that works with small businesses. For example, we’ve helped S corp owners uncover additional savings like this scenario:
A single owner of an S corp home contractor takes a $50,000 salary from his business. His S corp also pays for his health insurance which is $15,000 a year. On the owner’s personal W2, he shows that $15,000 as additional salary – but no tax is taken out. Then, that $15,000 can be deducted on the owner’s corporate return since the company is paying for it. And on the personal return, it is also deducted as an adjustment to income, so you are not paying taxes on it personally.
Another consideration is that many States now allow what is called a Pass-through Entity Tax. This provides additional tax savings not available to Sole proprietors (including Single member LLCs).
If you’re wondering “should my business be an S corp” – you’ve come to the right place. Our team of CPAs have helped hundreds of small business owners answer the exact same question.
When seeking out the best accountant, beware of one that pushes you into setting up an S or C corporation – without first taking time to understand your needs. Yes, an S corp can provide serious benefits, but it does take more work. Together, we can decide if it’s right for you.