S-Corporations vs. LLC: Income Tax Savings Benefits
I am the President and CEO of a uni-national corporation. A one-person S-corporation, to be exact. I chose this over an LLC for a variety of reasons (most of which I don’t remember anymore), but one of them was - what else? - to save some money. I wrote a relatively wordy post a few years back on Forming An S-Corporation To Reduce Self-Employment Taxes. But I just read this e-mail from MyCorporation* that has a concise example with a nifty graphic thrown in:
In an S-Corporation, only earnings paid to an owner as salary is subject to payroll taxes. Any money left in the business for reinvestment or distributed to the shareholder as a dividend is not subject to self-employment tax.
Maria is a sole proprietor bringing in sales of $90,000. After she pays her costs & expenses, her profit is $60,000. As a sole proprietor, she is required to pay self- employment tax of 15.3% on this entire $60K of profit, which equates to $9,180.
Now, let’s assume Maria formed an S-Corporation for her business, and chooses to pay herself $35K for the year in salary, and take the remaining $25K of profit through a distribution. She still earns the same $60K in profit. But, let’s look at the tax situation. Because corporations only pay Social Security & Medicare taxes on salaries, she’s only liable for $5,355, saving over $3,800 in taxes!
If you have a single-person LLC, the tax situation is usually very similar to that of a sole-proprietorship. (I should add that in some states you can also choose to have the LLC taxed as an S-Corporation. I would consult a local attorney for more details on this.) Now, the salary has to be “reasonable” based on the compensation of similar work elsewhere, so don’t get too crazy with this.
The catch? As an employer, the S-Corporation has to pay unemployment taxes. The exact rate varies from state to state, but the federal minimum is about $450 per year if your annual income is at least $7,000. However, as both the employer and employee, it is very difficult for me to actually “lay myself off” and claim unemployment benefits. So this fact cuts slightly into potential tax savings.
* I actually used LegalZoom to file my incorporation papers, but right now their competitor MyCorporation is still offering free LLC or corporation filing with promo code MYFREE (same thing costs $139 at LegalZoom). You still have to pay the registration fees charged by your state.
Find more in Self-Employment, Taxes | 2/13/09, 4:19am | Trackback
February 13th, 2009 at 6:10 am
So when you file your taxes… do you have to file the company’s taxes separate… at which point you send yourself a W-2?? Or are you somehow able to combine it all into one tax filing? I’d like to hear your results after you file your taxes for 2008 if you haven’t already, or your experiences with it overall.
February 13th, 2009 at 7:03 am
I’m wondering how the tax computations would pan out if the S-Corporation would be formed as a joint venture (i.e. two co founders). What if one resides in one state and another one in a different state? What if the S-Corporation is multi-national (i.e. one co fonder in US and one in Canada)?
February 13th, 2009 at 7:05 am
I’m a big fan of the S-Corp. It’s my recommendation for most clients. Avoiding the SE tax is a big help, especially come April 15. Many people, regardless of what I tell them, are always shocked to see a jacked up tax bill because they forgot their freaking SE tax.
One of the draw backs for the S-Corp is that you have to file an 1120S. From that you get the K-1, which flows through to the 1040 personal return. Single member LLCs don’t have to file a separate return, just the Schedule C on the personal return. The accounting requirements/fees just go way up with an S-Corp.
Another draw back to the S-Corp is that there is no way around quarterly filings for payroll. Many sole props/SM-LLCs don’t have any employees so you can just do “protective” filings (payroll returns with zeros across the board). I’ve had a lot of clients that find out the hard way that the IRS plays games with income taxes, but they are DEAD SERIOUS about payroll taxes.
The other thing about S-Corps is that you have to a “reasonable salary.” But what the hell is a “reasonable salary” for the owner, CEO, CFO, secretary, and lead plumber all rolled into one person? The IRS is so upside down right now, though, I’ve seen people get away with not even paying themselves a salary for years. Sigh…Also, reasonable salary has absolutely nothing to do with your profit for the year.
February 13th, 2009 at 7:43 am
I think another option is to open up an LLC but elect to be taxed as an S-Corp. As I understand it gives you best of both worlds.
Additionally, 50% of SE tax is deductible so something to keep in mind as well.
February 13th, 2009 at 7:57 am
My accountant reduces my taxes for the LLC by changing up the distributions. My partner (my husband) actually receives most of the distributions, so that my SE tax is lower. It works out well, and upon analysis, I save just as much with the LLC as with the S-Corp. — but the accounting procedure isn’t as involved.
February 13th, 2009 at 8:08 am
Here, here for the S-corp. Pass through that income baby. Social Security isn’t going to be around when we’re old enough to collect it, so why pay into it!
Now, with all this hyperinflation talk around the corner, I wonder if now is the best time to start buying everything I might need for the next 5 years and stop hoarding cash.
10 pairs of sneakers, check…
500 rolls of toilet paper, check…
heh
February 13th, 2009 at 8:47 am
Miranda- What your accountant is probably doing is allocating percentage owned by you and your husband. The distributions do not factor in at all, unless you’re distributing beyond basis. I would hope the acct has you filing the Form 1065 and putting you in as passive, husband as active.
February 13th, 2009 at 10:10 am
One thing to also keep in mind in your personal liability. I am not 100% sure on this but incorporating as a LLC actually removes your personal assets from the equation if someone decided to sue you or if your business goes bankrupt. Is this also true for a S-Corp?
February 13th, 2009 at 10:21 am
I have an S-corp. It is a good point made about tax prep, as you need to generate the 1120S and K1, but those expenses are fully tax deductible as well.
The benefits of not paying as much in FICA taxes greatly outweighs the formation and tax prep costs for a profitable S-corp however.
Another thing that I do is I’ve set up a solo-401K. As an example, a person paying themselves $60K in salary could sock away as much as $30K into a solo-401K if they wanted to. Significantly lowering your tax burden.
One point not brought up is that by paying less in FICA now, that could possibly affect the amount you eventually receive from Social Security. Looking at the shape Social Security is in, I think I’m happy to take the immediate benefit.
February 13th, 2009 at 11:44 am
@Maury - My accountant always asks me every time we meet “you are putting your fica savings into your retirement accounts, right?” that’s exactly what I do.
@jacob - LLC or S-corp, if a lawyer is good enough, they can always strip away the “veil of liability”. With these types of situations, it’s best to ignore any legal benefit. After all, it’s just a few pieces of paper that separates an individual from an LLC or corporation. They aren’t exactly like waiver’s signed by your customers excusing you from responsibility.
February 13th, 2009 at 4:16 pm
If I have “XYZ Co.” It isn’t an LLC or corp. How do I go about doing the taxes and trying to save money on the taxes for sales done in 2008? I purchased home and business turbotax.
February 13th, 2009 at 7:10 pm
But what about the corporate taxes?
The S-corp still has to pay corporate tax on the corporate profit that you did not distribute to yourself as salary.
Yes, this is usually lower than income tax, but if you count the extra accounting an S-corp has to do (shareholder meetings, extra tax filings), it’s almost a wash.
February 14th, 2009 at 8:35 am
The “free” MyCorporation “deal” is a scam - in my old state it cost 50 bucks to set up LLC get EIN and a-Corp status from the Feds total - all with a simple fax. They still want like $150 after the supposed deal.
Also to the guy who’s thinks SS is a mess - take a look at how 401ks have done … SS will pay out. Period.
February 14th, 2009 at 9:03 am
As a CPA I mostly agree with Zack. Good points. We generally don’t recommend S Corps to our smaller clients because of all the expenses involved.
I disagree with the statement about the IRS not caring if you pay out salaries. I can assure you they care. We have a lot of personal service clients (mostly doctors). It’s actually a high audit area for our client base. BUT that being said, we tend to the conservative side. Most of them pull at minimum $230k salary for full retirement benefits (They can then put $46k into profit sharing/401k, tax-free). I have heard some pretty lenient formulas, like $30k salary would suffice even for some of our clients. But I would never recommend a profitable S Corp. take no salary unless they want IRS knocking on their door.
BTW - to Steve - there is no corp. tax at the federal level, on S corps! Some states do tax, but it is pennies. California is a whopping 1.5%.
February 14th, 2009 at 11:57 am
Steve,
I’m not sure that is entirely accurate… An S-corp does not pay taxes like a C-Corp does. S-corp earnings (whether distributed to shareholders or not) are included on the shareholders taxes. There is an informational filing given to shareholders (K1) but that is it.
Shareholder meetings take me all of 30 seconds. I have a template, and once a year I change the date, print it out and sign it.
Someone does my S-corp taxes for $300… So the FICA savings on $2000 alone covers that.
For each $1000 more I take as distributions instead of salary, I save $145. On $40,000 that would be close to $6K less in taxes I pay.
It is WELL worth it to form an S-corp if the business is profitable. Otherwise, you are just giving away 14.5% of your income that you don’t have to.
February 14th, 2009 at 1:55 pm
Jacob, Justin- Lawyers can usually get around the corp/LLC to the owner because of co-mingled assets. The more formal you keep the business and your personal stuff, the better protected you’ll be. Don’t go buying stuff for yourself personally with the business money, don’t loan money to the business without paperwork, etc.
Boo - You’ll have to fill out a Schedule C for 2008. This is just a schedule on your personal tax return just like itemizing your deductions. If you’re dealing with a good amount money, you will probably want to see a professional to learn the ropes. Then you can decide if you want to do it on your own. You also really need to file a DBA with the state. You should probably just go ahead and get an LLC.
Steve - Sorry, but you’re wrong on that. All income flows through to shareholders and is taxed at the individual level, as Maury said.
I think it’s also important to note that the S-Corp doesn’t make a lick of difference in courts (excluding tax court). S status is known as a “check the box election.” Only the IRS really cares.
February 14th, 2009 at 5:11 pm
we (wife and I ) did the same thing went from sole to s-corp
saved about $8.000.00 a year..
February 15th, 2009 at 8:30 am
Couple questions that I don’t believe are covered above -
1) Doesn’t Corporate tax need to be paid by the S-Corp?
2) You will have to pay additional tax on your 1040 for the salary portion
3) Any additional distributions (ie. dividends) back to you for earnings in excess of your salary will be taxed?
Maybe I’m off base, but it doesn’t seem like everything is being included above
February 15th, 2009 at 1:17 pm
@york
1) was covered and recovered
2) Yes.
3) Yes, but you don’t pay fica on this amount. That’s where the savings comes into play.
February 16th, 2009 at 12:01 am
I’m new at this, so please correct me if I’m wrong. This incorporated advantage only applies to those who own their own business, or is able to work as an independent contractor for a company and go through 1099 status right? If the company is only willing to hire you as their employee and only issue a W2, then this is not possible. If there is a way around this, I would love to know. Much thanks.
February 24th, 2009 at 8:22 am
Off topic, but Johnatan hasn’t posted in a few days. Anyone have word if he is taking some time to himself away from the blog, or a vacation? Just curious.
February 24th, 2009 at 11:44 am
Hello - so if you have to do a tax return for the S Corp but there is no taxes on an S Corp then why do you need to complete a tax return? Just curious..
February 24th, 2009 at 3:14 pm
NY GUY - Are you sure you are getting refreshed version of the site?
Karla - S-Corp needs to file so you can figure out profits/expenses/capital, which shows how much flows to shareholders. Then the shareholders get a K-1 form listing their share of the income.
February 25th, 2009 at 7:22 am
Very strange, I wasnt getting refreshed pages of the site. I have never had that happen to me before. Oh welp, I have a few days of read to catch-up on now.
Good to know nothing bad happended, as I thought you just stopped posting unexpectedly and without notice.
February 25th, 2009 at 9:59 am
Might be a problem on my end with my cache plugin, but visitor counts seem to be normal. Feel free to let me know if it happens again.
February 25th, 2009 at 10:17 pm
I’m in CA. We are a LLC filing as an ’s’ corp. First time. Old accountant said pay my husband payroll and pay taxes etc. file 941 and so on. He died. New accountant says we should not have paid payroll and get it all back from feds. Called IRS and they said we did right. Called new accountant back with IRS news and he said they must not have understood we are a LLC filing as s corp not s corp. Ready to scream. Please help!!!!
February 26th, 2009 at 3:48 pm
Julia-
Fire your new accountant.
When you “check the box” to file as an S-Corp, you essentially become an S-Corp in the IRS’s eyes. Meaning you do officer salary, file an 1120S, etc. You did right by filing the payroll returns.
February 27th, 2009 at 8:04 pm
I am an s corp filing with a K1. I have not taken any payroll taxes out during 2008. Do I need to file a Schedule SE along with my 1040 and pay self employment tax? Or is that coming out of my taxable income on my 1040?
I’M CONFUSED!
March 1st, 2009 at 3:20 pm
I am switching from sole to a one person S corp. My question is whether it’s better to give myself a larger salary or take more distributions? My accountant seems to want me to take as minimal a salary as I can (just enough to cover my monthly bills) and take distributions when I need more money. Do you all agree??
March 2nd, 2009 at 6:11 pm
i have the same problem as george. I never gave myself a payroll. I just took money out of the business account when I needed it. (first year as s corp, didn’t know any better) So now how do I claim that income? on my k1? or as other income on my 1040? Or do I w2 myself now? I used taxcut software and am just hung up on this one spot.
March 3rd, 2009 at 12:48 pm
George, Jana-
1) You guys should really consider getting a professional.
2) DO NOT complete Schedule SE. At this point, it’s too late to really do anything about not taking payroll previously. See #1 above.
3) Distributions aren’t income as long as you did not exceed your basis. Accordingly, see #1.
March 3rd, 2009 at 1:09 pm
I actually had mine done by a professional and they were going to include a Schedule SE, and a schedule C that was just zero’d out, but it didn’t seam right to me so I didn’t file it yet.
So from what I gather the correct way to do this for this year would be to take a salary in which I pay payroll Taxes on filing quarterly and I will W2 myself at the end of the year?
Then anything extra comes out as a distribution?
Your help is greatly appreciated.
March 4th, 2009 at 11:38 am
Being a SBO myself working as a consultant, I found LLC and SCorp works the same ways. Right now, I have my company as LLC
I take out Guarantee payments which is counted as an expense for LLC. As per tax goes, I only pay SE tax for the guaurantee pay and not the business income. So that it works same way as Scorp. You don’t have to form Scorp just to save on SE tax as it can be done via LLC as well. You also don’t have the hassle of filing quaterly reports.
But there are obvious drawbacks to LLC. You can own a health insurance account in LLC (husband and wife). I think its tough to do Solo 401 but can do SEP and so froth.
I also learn few things about scorp here. Good stuff!!
March 4th, 2009 at 1:55 pm
vijaianand-
Except that you’re wrong. On almost everything you said…You need an accountant with good business tax experience.
March 4th, 2009 at 2:24 pm
Can you explain what exactly is wrong? I know I stated “You can own a health insurance account in LLC (husband and wife). ” It should be “You can have your own a health insurance account in LLC (husband and wife) to claim the insurance reimbursement ”
I usually don’t claim something just because I know it. I do research and learn from other mistakes. Here is some titbits from different tax guys,.
Check out this link
http://www.taxalmanac.org/inde.....rom_an_LLC
Check out this website. They have lot of discussions on this topic..
Please don’t just claim something wrong without any proof.
Vijai
March 4th, 2009 at 2:49 pm
Zack,
Can you tell what exactly is wrong? I know the health portion I got it other way around. I actually posted a comment with website link which is discussed by many tax preparers, CPA’s and very broadly on this topic. I guess its stuck for moderation..
I usually don’t comment on things unless i am pretty sure after all the research.. You can check out once its posted and let me know.
Vijai
March 4th, 2009 at 3:38 pm
Vijai-
1) I didn’t explain why you were wrong cause it’s tax season. I’m a tad busy.
2) You were wrong on several things. You really should see a pro, if only to see the general format and then ditch them later. I tend to think it’s a little low brow, but people will continue to do it for all time.
3) I’m well aware of TaxAlmanac.org.
4) The link you posted seems to have little to do with what you were talking about previously. Unless you’re speaking about return of capital or LLC use of personal property. But then you have capital gains and/or rental income, just complicating your return, and daring the IRS to look at your stuff. To quote Tom04 from your link: “However, any distributive share of ordinary LLC ordinary income and guaranteed payments are subject to SE tax.” And Tom04 about designating some payments as return of capital: “I have ran across a return where the preparer designated a portion of the guaranteed payments as return of capital and deducted this amount from SE income. However, I don’t see any basis for this approach.” I completely and totally agree with Tom04 on this. The IRS would also agree, otherwise there would be no point to an S-Corp! Please also note that the return of capital would have also been previously taxed as income, so this isn’t a magic tax loophole.
Having said all of that, I still think you should see a professional with good, solid business tax experience (See #2). And be careful on TaxAlmanac.org…they tend to talk about VERY specific situations.
-Zack, CPA
March 4th, 2009 at 6:18 pm
Zack, actually I been looking out for a tax guy who can my return since its bit complicated for this year. I did for last year with only W2’s but this year I have contract job and with retnal income and stocks and so forth got too complicated. I managed to do my 1065 for LLC but still few questions unanswered. My hunt is still on because no guy is expert in everything and everybody says different. I did check out a lady as you said but she was totaly wrongly telling me to file Sch. C which is only for sole propertorship.
Anyway coming back, I think I am write about telling you can take Guarantee pay for partnership from LLC which is an expense and pay SE tax. I am still trying to find after all deductions, whether on the business income I need to pay SE tax as well since its a multimember partnership. SCorp is different compared to LLC but not a lot according to may CPA’s I talked to. There expense and Income flows the same except you get to pay yourself a salary and company deducts the FICA instead of LLC you pay SE Tax. The end of year profit still flows to the 1040 as distribution like LLC. So they are almost as per my research. Please correct me if I am wrong whenever you get a chance.
Also according to biztaxtalk.com discussion, its is tough to form a self health insurance in LLC but easy in SCorp which is good. So they both have pro’s and con’s but LLC is less hassle and still have advantages.
Please just let me know whether the end of your profit income from the business has to deduct SE Tax for multimember partnership as per you.
Thanks
March 5th, 2009 at 8:03 am
Actually, if it is a single member LLC you only need to file the Sch C. Some firms make people do the Form 1065 for all LLCs, but there’s no legal requirement behind this. I think it’s for two reason, neither of which benefit the client: 1) You limit the firm’s liability to one form or the other (the all the eggs in one basket type deal). 2) Boost up fees for more prep work. Now, if it is a multi-partner LLC then you file the Form 1065.
The guaranteed payments can absolutely be taken as an expense for the LLC. However, for example, say the LLC profits (before any GPs) 100,000. You take 60,000 as a GP. You pay SE tax on that GP. Then the LLC shows 40,000 profit. You still have to pay SE tax on the LLC’s after GP profit. So now you have 60,000 SE income from the GP and another 40,000 SE income from LLC profits, for a total of $100,000 in SE income. So GPs are a wash in a single member LLC.
In a multi-member, GPs can be used to pay a member for work/services performed beyond the partnership agreement. For example, say there’s a coffee shop owned by a couple of guys. The partners usually only do managerial duties, etc. One of the baristas ups and quits. So one of the members ends up working the shop for a few weeks, which is beyond the management duties he usually performs. The partnership agrees to pay him for that. I’ve also seen them used for health insurance purposes. I actually rarely see them. There are situations where they help, but it’s usually not worth it.
What you’re missing in this whole discussion is FICA/SE tax. This is where S-Corps and LLCs really differ in a VERY significant way. Reread this article. Say the LLC had made 100,000 (No GP since they would be a wash) and S-Corp made 100,000 (before owner’s salary). Reasonable salary is 35,000. You pay FICA on that. Then you only pay income tax on the remaining 65,000. Whereas on the LLC you would pay SE (ie, FICA) on 100,000. So you would save 65,000 x 15.3% = $9,945 (roughly speaking, naturally). If you can handle the additional overhead on accounting fees, the S-Corp is usually worth it.
Remember, reasonable salary in an S-Corp has NOTHING to do with profits. I’ve never seen that withstand audit. Employees always get paid, regardless of financial performance. Well, besides bonuses that is.
Also, don’t go preparing tax returns off what some random guy says on the internet. Keep looking for somebody. They will sign the return and give you that barrier of protection. Open your wallet and get at least an EA. I would go with the CPA since they tend to be better with businesses in my experience. Just be aware you’re talking some scratch either way.
March 5th, 2009 at 8:32 am
Zack,
Thank you for taking time to explain in detail.I appreciate it with all the examples. But I was told and read in books that profits from LLC for a multi member doesn’t have to be considered for SE tax. But you were saying, it has to be considered. Since its a partnership, doesn’t it flow only thru the return as a income and pay income taxe like any other income from rental property. Why does it have to be counted for SE tax? Every person/CPA I talk to say it differently. I might have to call the IRS SBA line and verify it.
Also, thanks for advise on going with a CPA. I am actually looking for one and don’t have problem paying but I am having tough time find the right person. They are also asking too much which is what killing me because I almost got it complete except few things. Will keep trying.
Thank you again!!!
VIJAI
March 5th, 2009 at 2:32 pm
I am a new s-corp formed from an LLC in 2008, sole shareholder, only employee. I wonder if someone can explain to me why “friends” try to drain their own s-corp accounts to $0 at year end. I take a regular $24k payroll, pay regular taxes and take an occasional distribution throughout the year for unexpected personal expenses, but minimal. I was fortunate to have good gigs last year and ended up w/ $26k in the S-corp account, which then was put onto my personal taxes. I just can’t see taking a huge distribution like that and avoiding the IRS! Also did I avoid paying FICA on that $26k?
What am I missing?
March 6th, 2009 at 7:19 am
Amy-
I assume you’re talking checking accounts…I the S-Corps are cash basis and that they are just loading up on expenses. Otherwise, they get to pay tax on any income not spent on expenses. They might be committing some tom-foolery, but you don’t want to copy that anyways. And yes, from the description you’ve given there was no FICA on that 26k, assuming it was all profits and assuming your accountant did not accrue some salary at the end of the year.
March 7th, 2009 at 10:32 am
I am still trying to understand one thing. Can I form as a single member LLC but then file as an S corp for tax purposes? Does this get me around the SE taxes beyond my reasonable income…without the extra paperwork? My only purpose in forming is for the SE tax break. Or do I need to form as an S corp?
March 9th, 2009 at 7:41 am
Vijai-
I think what you might be talking about is active versus passive.
I’ve done some more research on this, and I actually found something (a footnote in a resource book) that backs what you were saying earlier. Boils down to this: there are no court cases to back this, but word of mouth from a tax seminar guy says that IRS auditors allowed GPs for reasonable salary in an S-Corp and the rest as only taxable for income tax (SE tax exempt).
This still strikes me and my coworkers as an incredibly aggressive position. And I mean INCREDIBLY AGGRESSIVE. The firm I where I work tries to stay off the IRS’s “radar.” We don’t like audits, clients don’t like audits. We would never take this position without substantive authority on this (eg court case, rulings, etc) and this second hand gossip would not cut it. This also goes contrary to every return I’ve ever seen done by other firms (incl. big four, specialty accounting firms). And lastly, why take such a position when you could just elect S-Corp?…
Allow me to amend what I said earlier: instead of an accountant, you may want to consider a tax attorney. Tax attorneys are typically more willing to take iffy positions. If they are willing to sign the return, go for it. Just be sure to ask about penalties and interest on this sort of thing. And keep in mind that you’ll probably receive notices about it and accounting fees add up quickly.
Rebecca-
There’s tons of extra paperwork, but yes, you can elect corp status then S-Corp status for an LLC.
March 9th, 2009 at 8:13 am
I have a perculiar situation and have read the insightfull contributions on this board. I believe I am in the right track but still want to explain my situation and I will appreciate some feedback…
I am single owned S corp, who also have a full time w2 employment. My S corp is in a startup phase right now.
I did not pay estimated taxes; after expenses & loses; S corp distributed income was about $4K. Before this, I have paid myself a salary of $4k and dividend of $1K. I have already filed 1099-div/w2/w3/1096 for the $4K & $1k payments to myself.
Question:
Should I be worried about SE on the $4k salary?In my other job, I make well above $100K; so I would have contributed more than the max of FICA there, except the medicare portion of FICA. I also use a tax preparation software, that automatically calculates my total income against my withholdings and tells me if I have a return and how much or if I own uncle sam and how much.
Since money get taken out of my other job and uncle sam owes me money at the end of the day, do I really need to border about paying estimated taxes? In my other job, I am claming zero dependent, but I actually have 4 dependents that I will claim during tax filing, I did this so that uncle same to get a larger share upfront.
I also intend on reporting the income of $4k as indicated in my K1 in my personal tax filings, along with the $4K w2 and $1K 1099-div and w2 from my day job and leave the rest to my turbo tax or Taxact software to figure out the rest. comments…
March 9th, 2009 at 1:09 pm
I need HELP! please! I incorporated as sole shareholder in May 08 with the state. After doing so and spending some monies to start my business, I had a ’situation’ that caused me to put everything hold. Now I find out I have to pay myself a salary and claim it as income on my 1040. (yes, I know I need a pro but, as noted, with the company on hold, I made $0 from it in ‘08). I did volunteer to a client who was suppose to, in return, help me advertise to other businesses. My question is, what is a “reasonable executive salary” if I made no money? Also, can I claim any of my expenses? If so, can the negative dollar amount on my 1120 be put into my 1040 somewhere to help? I’m lost here.
March 9th, 2009 at 1:37 pm
Zack
Thank you for taking time to do some research. I am totally with you. I don’t want to get audited as well and dig my own hole. So I actually decided to go the route which is usual for LLC. I ended up paying taxes for the full business income including GP. I am thinking of electing the SCorp status this year so I can file differently next year. I might have to file an election form to change to SCorp which I need to find out. If you can just share the process that would help whenever you get a chance.
Thank for helping us on your busy schedule.
VIJAI
March 10th, 2009 at 10:12 am
Vijai-
I think it’s Form 2553 if you’re already a C-Corp. Otherwise, you have to fill out another form to elect corporate taxation then elect S-Corp. It’s not hard; just “check the box.”
Sandra-
This is one of those situations that you really have to sit down and discuss with someone. You can probably take some of the expenses. You’ll probably be okay without the salary due to -0- income and limited operating time. Yes, any losses from the S-Corp can help on your personal return.
Stance-
You’ve got several issues here that I don’t have time to go into. Other than that, this is truly an impossible question to answer without seeing your previous returns, last year’s information, basically everything. Best advice: be prepared to open your heart and wallet. Also, get a professional!
March 10th, 2009 at 12:39 pm
Zack,
I have done a lot of research online and talked to IRS with no help with what to do regarding the “compensation” and according to the IRS I have to file the 1120s and the 2553 (I think) by March 15 at the latest. If I set forth that my salary is only say… $25 a week plus a certain percentage of profits, will it raise red flag?
March 10th, 2009 at 1:31 pm
Sandra-
Form 7004 is your friend. http://www.irs.gov/pub/irs-pdf/f7004.pdf
If you do salary for previous years (eg 2008), you have to go back and file Forms 941, Form 940, and any state forms. This would cause significant penalties and interest compounded daily and headaches and nightmares… You might be better off not including a salary at this point. However, if you are going to continue the S-Corp, you need to get on top of the IRS ball.
Also profits do not key into “Reasonable Salary” at all. There a lot of questions that go into salary determination, incl. hours worked, responsibilities, employees overseen, etc. Just like a normal job.
March 11th, 2009 at 6:31 am
Maybe that is my key: “There a lot of questions that go into salary determination, incl. HOURS WORKED, responsibilities, employees overseen, etc. Just like a normal job.”
So, if I just pay myself by the hour, even if it’s a high hourly salary, as should be for the owner of a company, it would be very little considering I only really put in time in the beginning. Hmmm. Good call. Thank you. And yes, I NEED to get on top of the IRS ball!!!!! More importantly, I need to get to work putting this great idea I have into action. I decided to do that and quit letting the little life issues get into the way. I even ordered my business cards yesterday in order to begin my “plan” as I had set out in the beginning. Wish me luck!
March 11th, 2009 at 4:51 pm
Hi, would it be possible to get recommendations on software (bookkeeping, etc.) that is ideal for s-corp’s? This business is and will be run only by myself and I want to make certain I cover all my bases throughout the year so that I’m not scrambling and stressed over a lot of what’s mentioned above.
Thanks - Ashley
March 17th, 2009 at 8:33 am
Hi All… After MUCH frustration I finally broke down and bought TurboTax for business on Sunday. Monday night I finished my corporate taxes just in time to e-file. WHEW! I will be buying TurboTax every year. It made it MUCH simpler.
March 22nd, 2009 at 12:05 am
I have a question: I am planning to open a small business this summer and am expecting a loss this year due to the costs involved with getting started, and not having many clients intially. I will be the only official employee but my husband will be a 50% partner and will help with the marketing. We have significant other income to offset (from a severance package - yup, the economy hit us and we have decided to take matters into our own hands!) Anyhow, I am wondering if the best way to take advantage of losses would be to start out as an LLC (so do not have to pay salary) and then switch to S-Corp at a later time when we have profits. What do you think?
Also - unrelated question: We could be spending up to $75,000 in consulting fees for help with opening this business. I know that we can only deduct $5,000 for start-up costs. If some of these consulting fees are not incurred until a couple months after the business opens, can we then deduct more than the $5,000? This is an important issue for us, as we expect to be in a high tax bracket this year (low tax bracket next year, due to business start-up.)
Thanks so much for your advice! - Danielle
March 25th, 2009 at 10:46 am
I am a sole proprietor and want to go LLC or S corp. After reading this whole page I still don’t know whether to go LLC and file as S-corp or just go S-corp. I have income of about 70K.
March 25th, 2009 at 2:17 pm
I filed to incorporate and received my incorporation papers on 12/3/08 - can I still run all of my 2008 income through my LLC/s-corp? Or only 1/12 of it - I have a financial advisor telling me one thing and the cpa telling me another - HELP! I hired THEM to be the experts, not me
March 25th, 2009 at 5:33 pm
So the S-corp pays unemployment taxes on the 25k of profit from the example?
March 31st, 2009 at 12:45 pm
My business partner and I are trying to decide the most appropriate business form S Corp or LLC. We are both employed full time W-2 employees for non owned Corporations. We are starting an insurance brokerage firm in our off hours. We are not intending to take any money from the business other than expense reimbursement for many years and will use the profits to make acquisitions such as other insurance agencies or blocks of business. It may take a year or two to accumulate funds in the business entity to make those purchases and we would like to be taxed as lightly on those funds from year to year. Due to our employment we are in a relatively high tax bracket (100K+) each year.
What would be best, or does it matter?
March 31st, 2009 at 3:06 pm
Hi Guys,
I just got a contract job (roughly 6 month duration) I want to set up an S Corp to hopefully save some money in taxes. Its a part time gig thats paying me 700.00 per week.
Now from what I have read, I would have to schedule a Salary out of this, plus, I could draw from some distributions.
I mean when I schedule a salary, how do I take into account this is only a 6 month project, and I may not have a need for the Corp after the project is over?
I guess I need someone to help me with a game plan.
April 6th, 2009 at 8:46 am
SO, after all of this, I have an S corp (Filed in January of this year in Maryland) with a whopping $649 income (total, MUCH more in expenses) since we’re just getting started. We have filed with the IRS and received our EIN number (There are only two of us, myself and my partner) We have to file a form 1120 by 03/15/2010 according to the confirmation letter we received from the IRS. From what I gather, we do not have to file quarterly. Have I missed something here?
Thanks a million in advance.
-McDegga
April 8th, 2009 at 1:25 am
I have an S corp and I wanted to know is it possible to be on Per diem if you are working away from your home office location and still can take advantage of all the write offs?
April 11th, 2009 at 6:59 am
What a great forum! I have run an S-Corp for 3 years now and unfortunately the business ’service’ is no longer there. 2008 was my first year with no activity in the S-Corp (also have a w-2). I plan to keep the S-Corp for future ventures (if I can do so). With that said, do I need to file any forms annually when I do my personal taxes to let the IRS know that I didn’t ‘forget’…that I simply had no activity(other than my annual report to the state)?
Much appreciation. Thank you Zack for your responses to those above - great info.
April 13th, 2009 at 2:51 pm
Travis -
Yes, you need to file a “Zero” report. This means you still file a tax return for your S-corp - just showing no activity.
You will still need to pay any State annual filing fees/ biennial reports, etc.
April 15th, 2009 at 6:50 am
Quick question for all the tax experts! We are an LLC filing as an S-Corp. After my reasonable salary and all expenses, we have about $55k in ordinary business income. I’ve read all of the information above but just want one more confirmation. This $55k doesn’t have to be distributed to the single shareholder (me), nor do we pay any tax on it, right? It just gets carried over into the next year as a starting balance to be used for cashflow, correct?
April 15th, 2009 at 9:48 am
Zeiner-
It doesn’t have to be distributed, but you get taxed on it through your K-1. And, no offense, your last sentence just does not make any sense.
Travis-
In this situation, consider shutting down the S-Corp to limit liability to those already completed projects, especially on the tax side. Many factors go into that calculation, though.
April 15th, 2009 at 10:09 am
No offense taken - accounting lingo isn’t a strength. My phrasing and terminology is undoubtedly off, but I appreciate the help just the same.
Bare with me… in the table at the top of the page with Maria’s $60,000 profit vs her $35,000 Salary and $25,000 profit. Let’s say Maria had taken an additional $5,000 in shareholder distributions and left the remaining $20,000 in the company, would her K-1 be on the $5,000 or the full $25,000 profit?
I thought one of the benefits of the S-corp is that the money isn’t taxed until it comes out of the corporation. Why would the $20,000 be taxed if it hasn’t been disbursed or paid as a salary to an employee or shareholder? Once it is paid out in the following year, wouldn’t that money be taxed a second time?
April 15th, 2009 at 10:26 am
Zeiner-
The profit is taxed to Maria personally because it has to be taxed somewhere, either at the corporate level (see C-Corp) or personal level (ie, S-Corp or LLC, etc). You made the S election, so personal level.
1) I really hope you took an extension. The 1120S was due March 15.
2) What table?
3) What you have is 35K salary and 25K profit. Don’t say 60K profit, you’ll confuse everyone, incl. yourself.
4) The 35K should be on a W-2 and taxed accordingly.
5) The 25K is taxed as income.
6) The 5K doesn’t matter. As long as there is positive equity (generally speaking) in the company, distributions are not taxed, deductible, etc.
7) The benefit of the S-Corp is that there is no SE tax on the profit.
9) Again, distributions aren’t taxed, so no “double taxation.”
This distribution/dividends and S-Corp taxation is something that trips up a lot of taxpayers. With that level of income, you need to see a pro to make sure you’re picking up all of your expenses, that the payroll is properly handled, and that the forms are properly, completely, and correctly filled out.
April 15th, 2009 at 10:30 am
Thanks - that helps a lot. Yes - our accountant filed the extension. We’re just trying to wade through this on our own to see if it is something we can handle. Seems well worth the fee to get a professional to handle.
thanks again - you’re a gem!
April 16th, 2009 at 6:43 pm
zack, how can I contact you ? im looking for a cpa and consulting.
April 30th, 2009 at 7:55 pm
I get confused. In NC i was in trouble for tring to pay unemployment of myself, and later collect when i needed it. In florida they are on my ass about unemployment taxes.I have no employees. I am a sole proproiter or a s corp. what the deal?
June 3rd, 2009 at 4:02 pm
Hi, CPA and experienced LLC owners.
I have a question on per diem. I travel extensively on IT job. I would like to use per diem for the whole travel (not just meals). Right now I am one member LLC. I just wonder whether I need to elect to be taxed as S-corp.
Is it true that you cannot use per diem if you own more than 10% of your company ? As said in
http://www.businessmanagementd.....Page1.html
What if I don’t elect to be S-corp ?
Then LLC owner, much as a sole proprietorship, should be able to use per diem. Right ?
Thanks for your insights.
Hans
June 4th, 2009 at 1:42 am
Regarding per diem for a sole proprietor: you can only use government per diem rates for meals when traveling. The meal per diem rates vary by city. You cannot use per diem for hotels. This may not seem fair, but it’s the breaks. Keep track of your hotel bills!
June 4th, 2009 at 8:34 am
Thanks, Danielle.
Is there a document or IRS pub (page number ???) seconding what you stated. Is there any way for LLC solo or LLC taxed as S-corp, to use per diem for more than just meals, I mean for the trip including hotel, car rental, etc. ?
Who is eligible for the Max Per Diem Rate published at
http://www.gsa.gov/Portal/gsa/.....&noc=T
?
I appreciate your insights.
Hans
June 13th, 2009 at 8:18 am
I am going in to business with 2 other persons. What would be the best for us to file LLC or S-Corp we are buying into a franchise?
I wanted to know if it is best to have w-2’s for us being employees or do 1099’s? What would be the better savings for us in paying taxes?
We will be utitilizing a CPA so we will have a cost there either way.
I want to give the government what is owed to them but is which way is better for the company money savings if any?
June 15th, 2009 at 4:10 pm
I’m part of an S-corp of 3 and have 50% share. I am the only payed employee. We are having hard times right now and i’m wondering if we can lay myself off and draw unemployment.
June 15th, 2009 at 4:13 pm
I’m part of an S-corp of 3 and have 50% share. I am the only payed employee. We are having hard times right now and i’m wondering if we can lay myself off and draw unemployment.
June 21st, 2009 at 1:56 pm
Zack I have a question re: your answer to Zeiner on this point:
5) The 25K is taxed as income.
In reading from the example on the site about “Maria” I thought that if her S corp issues a distribution, the S corp won’ t pay taxes on it. The S corp will however, have to pay social security and medicare taxes on the amount of salary it’s paid to Maria and it will have to pay taxes on her salary at the state level (or, unemployment taxes).
Do you mean that when Maria gets the 25K, she will have to report it on her 1040, and that accordingly it will be taxed?
Just want to make sure I’m clear.
Thanks
June 21st, 2009 at 3:07 pm
Onlooker-
Sounds like you’re right. S-Corps pay payroll taxes (SS/MC, state unemployment, fed unemployment, etc). But no income taxes. S-Corps do not pay income taxes, so the profits are taxed to you personally (ie, on your 1040). It is then taxed for income taxes at the personal level, in addition to your W-2 from the S-Corp.
June 21st, 2009 at 6:45 pm
I have heard varying things about being able to file taxes as an S-Corporation even thought you are technically an LLC. Is this true? If so, would I really see the same tax benefit of not having to FICA on anything besides payroll?
Thanks
July 14th, 2009 at 9:03 am
I just bought a territory for a franchise (senior in home non-medical care - odd jobs, companionship, light care/cleaning/cook, driving). Most of the franchise owners have seemed to setup their business as an LLC. only few as S-Corp.
My wife and I signed for the franchise territory (10 years) as 50-50%. I’ve heard varying opinions on whether I should setup as an LLC or S-Corp, and whether to only have myself on the company, or to split with my wife. We want the simplest and most cost-effective (taxwise especially) setup for the business.
If I am the only one listed as owner for such an LLC, can I take something like a “owners draw” and then not have to pay the 15.4%? (as opposed to taking a payroll (employee) monthly?
Thanks
July 14th, 2009 at 9:04 am
fyi: the employees we will hire will all be “independent contractors”, so no official payroll.
July 15th, 2009 at 8:38 am
As long as you don’t live in California, LLC is the more flexible way to go. Generally an LLC can file as either a partership or as an S-Corp. The rules on LLC do change based on the state you live in, so you should check on it. Since you signed the franchise as 50-50 owners, the default method would be to operate the LLC as a partership, with each of you getting a K-1 with 50% of the income. You will have to pay self-employment taxes on the entire amount of income, unless you elect S-Corp status when you file your taxes. If you elect S-Corp, you will need to pay yourself a “reasonable” salary based on the type of busines you are in. If your wife contributes to the business, she would need to be paid a salary as well. The IRS takes a good look at S-Corps and salaries so make sure you don’t underpay yourself.
July 15th, 2009 at 9:12 am
DMR-
Danielle’s pretty much right, but you also want to look at the LLC 50/50 and making your wife or yourself a passive owner. That means no self employment tax on that person’s share. There are some technicalities to this, so I recommend a pro to CYA and argue on your behalf should something come up. You would also have to weigh the value of that vs. just a sch C and being done with it. With a 50/50 LLC you’ll have to file the Form 1065, which is just a PITA for a lot of people in your situation.
As for the owner’s draws, it’s just money you take out of the LLC; it has ZERO impact on the profit and the associated taxes you would pay (ie, it’s not an expense and does not reduce your profit).
July 21st, 2009 at 1:45 pm
Is there a break even point? What does it costs to hiring the tax/accounting professional? If it costs a $1000 and I’m saving $1000, net $0, I won’t do it because of the extra hassles. For a programmer in NJ, billing $100000, commuting 80 miles daily, paying tolls, having to buy medical insurance for his family, working at a client site, and employing his wife to visit the tax/accounting professional, is it a modest win or a big win?
July 22nd, 2009 at 1:52 pm
Bill-
For $100k, it might not be worth it. There are a lot of hassles, and unless you’re showing BIG profit (ie, being very conservative with what expenses you take, the pain in the butt just isn’t worth it. I also don’t recommend “hiring your wife” (you’d really have to “hire” her?!?). I think your situation would depend on how aggressive you want to be on your taxes. Ask someone for the initial consult, it’s typically free or at least the first hour is. Even if it costs a little bit, it’s deductible and at least you’ll know.
CPA rates vary wildly from location to location and with level of expertise/experience/frills. You’ll have to call and ask.
August 24th, 2009 at 3:29 pm
Greetings everyone,
I am currently employed full time (w-2) and I want to start a small transportation business. The business will be under my name but my husband will take part in operating it along with me. Which structure is best to use, (LLC or S-Corp)? We are leaning towards the S-Corp but need some clarification as far as which one has the best tax advantage.
September 8th, 2009 at 10:28 pm
“Zack Says:
June 21st, 2009 at 3:07 pm
Onlooker-
Sounds like you’re right. S-Corps pay payroll taxes (SS/MC, state unemployment, fed unemployment, etc). But no income taxes. S-Corps do not pay income taxes, so the profits are taxed to you personally (ie, on your 1040). It is then taxed for income taxes at the personal level, in addition to your W-2 from the S-Corp.”
Im confused. If the S corp doesn’t distribute the funds, is it safe to say that there is no tax on the fund’s remaining in the s corp? If that is the case, could the fund’s be distributed in another fishion? Say to an llc that owns the office building. Never mind the fact the owner A of the S-Corp is the same Owner A of the LLC property managment?
Lastly, When filing quarterly for S-Corp, do I use the same 1120-W that C-Corps are required to use?
If these anwers are very long and drawn out, please feel free to direct me to a web site or book for further reference. FYI, planning on forming S-Corp first quarter next year. Tryin to dot and cross is all.
Thanks
Matt
September 9th, 2009 at 4:11 am
Denise,
Some of the things that i have learned through my research:
S Corps are best if you will have employee’s. LLC’s are best if you will be owning property, obviously due to the laxation ability of LLC’s to ‘act’ like sole proprieterships. There are a bunch of different web sites that have great comparisons
September 9th, 2009 at 9:26 am
S-Corps are passthrough entities, so all income is still taxed even if not distributed.
September 9th, 2009 at 10:08 am
Matt-
The income from an S-Corp is taxed on your personal tax return, REGARDLESS if the money stays in the company or not, just like Jonathan said.
I also can’t think of anything that substantiates the LLC v. S-Corp with regards to the employees and property. All gains, losses, and depreciation flow through the same way with S-Corps and LLCs.
Yes, you could wipe out the profit from an S-Corp by leasing to an LLC that you own, but there are rubs. Namely, to withstand IRS audit, it must be an “arm length’s” transaction, which basically means that the rent is reasonable and was executed using standard business practices. Also, the LLC that owns that office building must then pick up the income, which flows back to (guess who!) the owner (who also owns the S-Corp). This means that you’ve just wasted your accountant’s and your time. I would think that the LLC might be useful if you have multiple offices available for rent in the building.
S-Corps are not required to file anything quarterly since they pay no tax (except payroll taxes…different discussion). Also, the 1120W is not required, just recommended to compute income tax liability. S-Corps file an 1120S.
In summation, drop the $1,000, hire a CPA, get some good advice, protect yourself from the IRS, save your time, and save some money on taxes while you’re at it.
-Zack
September 9th, 2009 at 12:08 pm
if you are w-2 already and make > 105k you dont pay the 14.2% to SS on any s-corp/llc earnings. just the taxes on income after all expenses, and huge retirement contributions! like 40k + if u earn enough on the side
it’s easy
LLC taxed as S-Corp way to go! feel sorry for CA people who have to pay 800 / yr for the llc though
September 14th, 2009 at 8:18 pm
LLC’s in NYC (and maybe others) isn’t subject to Corporation taxes, an S Corporation in NYC is treated as a C Corporation and is taxes at the Corporation level (double taxed).
Think about it it might not be as simple as a LLC is the better way to go.
September 16th, 2009 at 4:13 pm
zack,
Thank you very much for your insight and patience. I will continue to read as much as i can until the day comes that a CPA is a must. Do you have any recomendations for reading on this subject matter?
Matt
September 19th, 2009 at 10:25 am
Matt-
The best thing to read is the IRS publications followed by academic textbooks. Stop reading stuff on the web that’s not official (like this). I’ve seen the craziest stuff on the net.
-Zack
October 12th, 2009 at 11:06 am
I have been considering an LLC with s-corp election. I have a few questions.
1) How many dividend payments can be made a year? (can they be monthly, etc? I know some corps pay monthly dividends.)
2) How should I determine salary? For what I do the salary range is from 40-80k. I’d obviously like to be closer to the lower-end of that spectrum for the SE tax savings.
3) Would there be a benefit to have my wife as a member as well, or does it even matter?
October 16th, 2009 at 7:18 am
We have a 3-person S Corporation. One partner is leaving the corporation. We are buying her out for $6000. I know I report this as income to her on a 1099 and she will pay capital gains, but how do I report this expense to the two of us shareholders left on our books and on our 1120S? How does this affect our basis going forward? Thanks for your help.
October 25th, 2009 at 4:37 pm
Thank you for all the above information and conversations, they have really helped. I have a situation that I’d like to get some opinion on:
New business (2 employees and one other “investor) purchased a retail business in the beginning of Oct. We each paid 1/3 price of the purchase and own 33.3% each. We setup as an LLC and now I’m trying to decide if we should elect to be taxed as S corp. FACTS:
- 2 of us work for the company and get paid $x/hr for management and billed hours. We assumed it would have to be guaranteed payments (no tax withheld/must pay se tax). Our business was turn-key and will show a profit beginning this first year. (We are lucky, I know!)
- The 3rd “member” is a full time employee in a different business earning over 200k/year (not worried about SE tax as much since he’s maxxed out the ss earnings already).
- The “paperwork” required for employment taxes is what I do for a living outside this business, so that is seamless for me.
- We are located in ND (don’t have any special state rules for s-corp or llc’s except that we have “governors”, which is just terminology from my understanding).
My questions are:
1) Is it a no-brainer to apply to be taxed as an s-corp?
2) Is there ?’s I’m not asking or considering?
3) Assuming we go forward with llc being taxed as a s-corp, how can i handle expenses that we have in our operating agreement as NOT being reimbursed to any members? I have a business lunch or mileage…(I do already file a schd C for my bkkpng/tax work) but wouldn’t have a place to deduct this new business expenses (because I won’t have SE income from it???
THANKS for ANY advice you can send my way…
Jennifer