Your gross sales don’t solely determine your profit. That doesn’t have to be a hard lesson for first-time business owners if you’re smart about self-employment taxes. For solopreneurs, the way you structure your business can impact what’s left in your pocket after taxes. Using an S corp tax rate calculator can help you compare tax rates and determine which structure is the best fit for your business. For most, paying less in taxes is accomplished by filing as an S corporation. This is a route to strongly consider if you:
- Expect your business to do a minimum net revenue of $80K
- Operate a strictly domestic business owned by US citizens
- Would like to save 3% to 6% in taxes compared to other incorporation options
You may be wondering what makes an S corp better than a sole proprietorship or LLC as you’re navigating the tax logistics of self-employment as a solopreneur. Keep reading to see what’s on the table with an S corp versus other options.
S Corp tax rate calculator: comparing S Corp tax rates to sole proprietorships and LLCs
Should you just file as a sole proprietor when starting your own small business? This is one of the first big decisions new business owners bump into. Sole proprietors are considered self-employed individuals. That means that they pay self-employment taxes the same way that contractors and freelancers do. There’s no employer or entity to cover a portion of FICA taxes for Social Security and Medicare. With the self-employment tax rate at 15.3%, that can be pretty painful for your net take home.
Next comes the LLC. Most people are used to associating businesses with LLCs. LLC stands for limited liability corporation. LLCs provide liability protection while also potentially giving the business pass-through taxation. If you choose to incorporate your business as an LLC, your business will be separate from you as the owner. This frees you from personal responsibility for your business’s debt or liability, in most scenarios (don’t see this as a free pass though).
However, there’s a downside to LLCs when it comes to how your income will be taxed. As an LLC owner, you’d pay taxes on all net profits from your business just like the sole proprietors. Paying the self-employment tax rate will cost you more compared to the rate for employee taxes. While this is frustrating, it’s not inevitable. Business owners can reap essentially the same benefits of forming an LLC while reducing their individual tax burden by pivoting to an S corporation instead.
Tax perks of forming an S Corporation: paying yourself a salary to pay less in taxes
S corps are especially attractive to sole proprietors and solopreneurs because they offer liability protection and tax advantages. Like LLCs, S corps are pass-through entities that shield taxable revenue from being taxed at the federal level. As the owner, you’ll avoid double taxation by filing only with your state and local income taxes.
You’re also able to claim losses, deductions, and credits on your personal tax returns to reduce your personal tax burden. Essentially, forming an S corp is a way to avoid double taxation.
How does an S corp work? Business owners who use S corps can avoid high self-employment tax rates by being taxed on income at their individual tax rate. How? Get ready for the loophole.
Under federal tax law, S corp owners are to receive “reasonable salaries” that total roughly what an employer would pay an employee for the same work. That means you are being taxed at the same rate you’d be taxed if you were an employee.
There’s an extra twist. An S corp also lets you pay profits back to yourself in the form of shareholder distributions. This is basically a portion of your profits that you’re entitled to as a shareholder instead of an employee.
Unlike your salary, your shareholder distributions aren’t subject to Medicare and Social Security taxes that take big bites out of your paycheck. As a result, you’re getting the best of both worlds by only paying income tax on your distributions and payroll taxes on your salaried wages. You can incorporate as an S-corp if you meet the following conditions:
- Be a domestic corporation owned by a US citizen
- Have only allowable shareholders
- Have no more than 100 shareholders
- Have only one class of stock
- Not be a financial institution, insurance company, domestic international sales corporation, or other ineligible corporation
Forming an S Corp
The first step in setting up your S corp to reduce taxes is determining what a “reasonable salary” looks like for your role in your company. You can do this by researching average salaries from the Bureau of Labor Statistics (BLS) or working with an expert tax pro — Shameless plug, this is us!
Next, you’ll need to determine your tax obligation. Based on the salary you assign to yourself, divide the number by the number of pay periods used by your company. From there, you can calculate how much to deduct for FICA, income tax, and unemployment taxes from each paycheck.
The place where operating an S corp “get” business owners is administration. The reality is that maintaining an S corp takes dedicated administrative work. That’s time, energy, and expertise that most business owners don’t have. Let’s talk about the realities of doing S corp administrative work.
S Corp administration: what business owners need to know
While your business may be small, the accounting requirements for S corp management require some enterprise-level accounting knowledge. You’ll also need to establish and manage a business bank account. As covered above, S corp owners need to be diligent about keeping up with payroll and taxes. The right amount of taxes must be detected from every paycheck depending on whether your pay periods are weekly, biweekly, monthly, or quarterly.
In addition to managing standard income taxes, unemployment taxes, and FICA taxes, S corp administration also involves managing any estimated income that won’t be subject to withholding. Of course, it’s also necessary to keep impeccable records of all payroll transactions. Good records are important for swiftly getting through any potential state or IRS audits that could come up.
S corps also have intensive requirements for annual tax returns. Tax filing with S corp involves the well-known IRS Form W-2 wage and tax statement that reports an employee’s income and withheld taxes. S Corp owners also need to file S corp annual taxes using Form 1120-S. This is the income tax return required of S corps that reports your business’s income, losses, gains, tax deductions, and tax credits for the year.
For someone in the process of starting a small business, the idea of operating an S corp can be overwhelming because of the intensive administrative duties that go with managing so many moving pieces. Most entrepreneurs don’t have in-house accounting or financial teams to handle these arduous tasks. Fortunately, you don’t need to have a full-time staff dedicated to payroll and tax management to be able to reduce your tax burden by incorporating as an S corp. Countless business owners are managing their S corp administrative duties using a flat monthly rate through Besolo.
Solo S Corp with Besolo
Beslo offers enterprise-level S corp administration services for just $349 a month. It takes just 30 seconds to apply for member access to see if you can start running your accounting and tax work through Beslo. Try it today!
