The following is a discussion of how organizing your business as an S-Corporation can help to reduce your company’s self-employment tax obligations.
For individuals who are self-employed, there is an opportunity to reduce self-employment taxes through the use of an S-Corporation, be it Social Security-related taxes or those related to Medicare (known collectively as “self-employment taxes”).
Different Tax Rates
Individuals who work for another company may pay a lower tax rate and self-employed individuals will typically be subject to a rate that is higher. Individuals who work for another company are only personally responsible for part of these tax obligations and the balance will be paid by the employer. Organizing your business as an S-Corporation has the potential to help your company maintain a steady net income while reducing your total tax liability.
S-Corporation Distributions and Self-Employment Tax
Organizing your business as an S-Corporation allows some of your income to be classified as salary while another part of your income is classified as a distribution. While this will still cause you to maintain your self-employment tax obligations on the portion designated as “salary,” the portion designated “distribution” will only require you to pay regular income tax. This allows for the potential to save a significant amount of money in tax obligations.
Additional Consideration for Self-Employment Taxes
While it can certainly be advantageous to convert to an S-Corporation for self-employment tax purposes, there are some additional issues to consider. The Internal Revenue Service (IRS) may be more likely to investigate an S-Corporation when only a small portion of the company’s net income is designated as salary. As a general consideration, the designation should constitute a “reasonable” amount of the overall net income being designated as salary rather than a distribution. As what constitutes “reasonable” can be a fine line, it is advisable to discuss the distribution with an attorney.
ODGERS LAW GROUP helps individuals with business formation and the development of strategic business plans aimed to help maximize growth potential and reduce tax liabilities. To learn more about business law or to schedule your free consultation with Mr. Odgers, contact us by e-mail, call us at (858) 869-1114, or schedule your appointment online here.