Is It Time to Become an S-Corp? A Plain Look for Small Business Owners
Shankar Subramanian, CPABecoming an S-Corp can save thousands in self-employment tax. But it only pays off when your profit is high enough and you are ready for the extra paperwork.
An S-Corp is a way your business chooses to be taxed. It is an election you file with the IRS on Form 2553. A single-member LLC, a multi-member LLC, or a corporation can all make it, if they qualify.
Where the savings come from
As a sole owner or regular LLC, you pay self-employment tax of about 15.3% on all of your profit (the Social Security part stops at a yearly cap).
As an S-Corp owner who works in the business, you split your profit into two parts:
- A salary that you pay yourself through payroll. Payroll taxes apply to this part.
- Distributions of the rest of the profit. Payroll and self-employment taxes do not apply to this part.
The tax you save is roughly 15.3% of the profit you take as distributions instead of salary.
The rule you cannot skip
The IRS requires S-Corp owners who work in the business to pay themselves a reasonable salary before taking distributions. That means about what you would pay someone else to do your job. Paying yourself nothing and taking everything as distributions is a well-known red flag for an audit.
The extra costs
- Payroll for yourself, with quarterly payroll filings and a W-2 each year
- A separate business return, Form 1120-S, due March 15
- More bookkeeping to keep business and personal money apart
- State filings. In Texas, LLCs and corporations still file a franchise tax report each year.
When it usually makes sense
There is no single number, but the election often starts to pay off when your business profit is steady and above about $40,000 to $50,000 a year. Below that, the extra costs can eat up the savings.
Other things that change the math:
- How much salary is reasonable for your role
- Your health insurance and retirement plan setup
- The 20% qualified business income deduction, which changes when part of your profit becomes salary
Timing
To be an S-Corp for the whole year, file Form 2553 within 2 months and 15 days after the start of the tax year. For most businesses, that is March 15. If you miss it, the IRS offers relief for late elections in many cases, so do not give up on it.
Our advice
Run the numbers with your real profit, a real salary figure, and your real costs before you elect. We do this comparison for free on a first call, and we can file the election and set up payroll if it makes sense.
Sources: IRS Form 2553 and instructions, and IRS guidance on S corporation compensation.
Want help with this?
Book a free 30 minute call with Shankar. We will look at your numbers and make a plan that fits you.
