You could potentially save thousands of dollars on taxes.
If you get down this one major difference between having an S Corporation and an LLC as your business entity.
When you’re a small business owner, you get to choose between 3 main entities for your business. The most common (and most basic in my opinion) is a Sole Proprietorship. Then there’s the LLC (limited liability corporation) and than the lesser known S Corporation. These 3 are the main kinds of formations small business owners choose from.
I recently changed mine from a sole prop to an s corp this year.
Now there’s a good handful of differences (and similarities) between all these formations but this one major factor made me bite the bullet and switch over to an s corp.
It’s that you have the opportunity to save a decent amount on the taxes you have to pay.
As an S Corporation, you have the chance to set a salary for yourself, which will be some amount less than what you actually made for the whole year. It has to be a reasonable amount though, like what the average and/or median salary for your profession in your area.
So for example, if you made $50,000 in a year as your gross income, you can’t set your salary to like $10,000. It’d have to be somewhere closer to like $35,000.
When you file your federal return, you will be taxed only on the amount that is your salary while the remaining amount is considered “Investment Income” and does not get taxed.
Why? Because you’re a corporation. As a corporation you get to have stocks and shareholders (even if the sole shareholder is still you, the owner).
So to clarify, you need to register with your state as a corporation and you get the “S” status by filing Form 2553 with the IRS.
Just to show the difference once more so everyone really gets this:
Let’s say we have 2 different people. Bob and Ron.
Bob has an LLC. His business made $100,000 in gross income for the year.
Going by the standard self-employment tax rate of 15%, Bob would be paying approximately $15,000 in taxes for the year.
Ron has an S Corporation. His business made $100,000 in gross income for the year.
Ron gets to set a salary for himself, which he puts at $75,000 (a decent/normal amount for someone to make). That $75,000 gets taxed the 15% self-employment tax rate which comes out to $11,250 in taxes that he owes for the year.
So let’s see, 15,000 - 11,250 = 3,750. That’s $3,750 less that Ron didn’t have to pay simply because he had a different business entity then Bob.
I don’t know about you, but $3,750 is not pocket change.
Now there’s some stipulations from choosing to be an s corp, like you can only have up to 100 shareholders, only 1 class of stock, certain types of businesses can’t become an s corp, and so on. So please research this thoroughly before you make any major changes.
And don’t get me wrong, there is absolutely nothing wrong with choosing an LLC. They’re almost as easy to handle as a sole proprietorship. And whether or not you choose an LLC or S Corp, you get that amazing liability protection from your personal assets.
I just wanted to go over the main reason that I love this business formation and also why I’d recommend incorporating in general.
If you feel like this is something worth sharing, then please do! Spread the word! Knowledge is power. :)
Thanks for reading,