Tax Benefits of an S Corp Structure

In a previous post, we discussed the importance of choosing the right entity type for your boutique retail business (if you missed it – you can go back and read it here) In this post, I hinted at the benefits of having an S Corp structure in your business, but we’re going to dive in a little deeper today!

Once your business begins to grow & become more profitable, it may be time to look at the benefits of an S Corp structure. This post will break down what that means, some things to consider, and how to become an S Corp retail business.

What is an S Corp Structure?

Becoming an S Corp simply means that you have applied with the IRS to be taxed as an corporation, instead of an individual or partnership. That means that you will need to file a separate tax return for your business that is due on March 15 if you operate on a calendar year. 

Instead of being called an “owner” you will be called a “shareholder”, and there may be other legal requirements that you have to put in place, so make sure you chat with an Attorney to learn more!

Tax Benefits of an S Corp Structure

Once you become an S Corp, you become an employee of the company, and you MUST pay yourself a “reasonable salary”. It’s not a choice, it’s a requirement. So, you need to put yourself on payroll and pay yourself like an employee. That means withholding the necessary payroll taxes, and paying in the required EMPLOYER taxes on top of that. 

Although, this may seem a bit of a headache at first, this is important for a few reasons. First, since you are now an employee, the wages & taxes you pay are a deductible business expense, which will lower your taxable income. 

But second, since you are now an employee of your company, you are no longer considered self-employed, and you don’t have to pay self employment taxes (which is currently over 15% of taxable income)

That mean that any profits that you have at the end of the year (after paying yourself your salary + applicable payroll taxes) will only be taxed at your personal income tax bracket, and you won’t have to pay that ADDITIONAL 15+% in Self Employment taxes. 

Things to Evaluate When Considering an S Corp Structure 

So when is making the S Corp election a smart move? Here are a few things to consider:

You need to be able to afford to pay yourself a “reasonable salary”. How much is that?? Well, the IRS isn’t super clear on that. But, if you were to hire someone to do everything you do, what would you have to pay them? That’s what you need to pay yourself. To get an idea, you can Google “average salary of store owner in [your city, your state]” and you should get some answers. Remember you won’t just be paying your salary, but also the applicable employer taxes on TOP of that, so budget an additional 15% or so percent to cover the taxes.

What are the COST to switch to an S Corp? I recommend talking to a lawyer about getting their help to make sure your business is set up properly. After the setup, you may have annual costs to consider such as the cost for the annual business tax return, and specific taxes imposed by certain states. 

Let’s look at some numbers to help see this in action. 

Let’s say you currently have an LLC business that had a $100,000 PROFIT last year. You took about $80,000 out of the business as an owner’s draw that was not tax deductible, so you could easily pay about $15,000 in self employment taxes alone. 

Now, let’s say you put yourself on an $80,000 salary. Your business will pay about 15% on top of that in payroll taxes ($12,000), for a total of $92,000. That brings your business profit down to $8,000. You will NOT have to pay self employment taxes on that, which will save you about $1,200. 

Now, $1,200 isn’t a HUGE savings, especially considering you’ll likely need to pay that (or more) to file your business income tax return. But, let’s say you continue to grow and scale until you hit $200,000 in profit (pre-salary). Now, you’ll be able to take out additional bonuses (ie distributions) while still saving over $16,000 in taxes! 

In this case it is definitely worth it to make the switch! If you’re getting to a point where you’re reaching the $100,000 profit mark in your business, then I recommend reaching out to a tax professional to help you “crunch the numbers” and make sure it’s the right move for you!

How to Make the S Corp Election

To apply for the S Corp election, you will need to fill out and submit a Form 2553 . This needs to be completed BEFORE March 15th of the year you wish to switch to an S Corp status. There are some cases where a late election is allowed, but you can learn more about the specific instructions and rules on the form instructions.

Is an S Corp Election Your Next Step?

If you’re ready to consider an S Corp election to help you save some money on your taxes, then let’s chat! We can look at your numbers together to help you determine if it’s time, or if you’re better off waiting another year or two. Or, if you need to get some better financial reports to even KNOW what your current profit is, then let’s chat about a bookkeeping cleanup! Click here to schedule a time to chat!

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