If you’re just starting a business or think your current entity isn’t working for you anymore, it’s time to do some research.
A sole proprietorship can be good for a small company or an entrepreneur with limited assets. An LLC is a wise choice for a still small business with the risk of liability.
But if your company is making—or soon will make—higher revenue than ever before, it might be time to consider an S-Corp. An S Corp is a popular business entity for entrepreneurs and small business owners, in particular for the reasons listed below.
Business Owner Salary
One defining characteristic of an S Corporation is that you, as the owner of the business, have to assign yourself a reasonable salary. Although the IRS does not provide any specific guidelines on what a reasonable salary is, various tax courts have ruled on the issue to provide some level of guidance. The time spent in the business, the duties and responsibilities you have, and how much you pay other employees you might have are all considered.
For many small businesses, especially those without other employees, somewhere in the realm of half the profit would generally be considered a ‘reasonable salary.’ The means you could be saving 15.3% on around half of your profits compared to filing as a Sole Proprietorship. The best part is that the more your business is making, the greater your potential tax savings.
The reason many small business owners choose an S Corp and to pay themselves a reasonable salary is that FICA taxes (Social Security and Medicare totaling 15.3%) would only need to be paid on the salary and any additional profits would be treated as unearned income.
If you make $75,000 a year and pay yourself a reasonable salary of $50k, you would pay FICA taxes on the $50k. But since the $25k is unearned income, you would only owe state and federal taxes on that portion. That would save you roughly $4,000 in FICA taxes.
Like your traditional LLC, S Corps also offer liability protection to the business owner. What this means is the owner in question is not personally responsible for any business debts or liabilities. So if you’re sued, or your business is in debt, it can’t be taken out of your personal assets.
So if you have a lot of personal assets, or at high risk of being held liable, a limited liability business entity is the right choice for you.
Is an S Corp Right for You?
If you want to pay yourself a reasonable salary, save on taxes, or need liability protection—an S Corp could be the correct entity for your business. If you’re thinking about forming a business, or switching entities, it can be a wise choice to talk to an expert. There may be technicalities you haven’t thought about, or hurdles that need to be passed before you can take the next step forward.