Posted on September 20, 2015May 31, 2016 by Jan Roberg

Should Your LLC Be an S Corporation?

If your small business has reached the point where your self employment taxes are really hurting you, choosing an S Corporation status might be the answer to your problem.

If you own a single member LLC, the IRS considers that to be a “disregarded entity.” That basically means there’s no such thing as an LLC tax return. So, if you don’t make an “election” to taxed some other way, you’re taxed as a sole proprietor on your 1040 personal tax return. That means, you not only pay income tax on your LLC income, you also pay self employment tax on top of it. Ouch!

But as a disregarded entity, you may make an election to be taxed as an S corporation (or even a C corporation if you want to) instead of being a sole proprietor. So how do you know you might be ready to be an S Corp? Here’s my top three criteria:

1. Steady net income. If you have a loss on your business, that business loss can offset your other income on your tax return. One of the big benefits of an S corp is to reduce your self employment tax. If your business has a loss, you’re not paying self employment tax anyway so the S corp status wouldn’t provide much benefit there. A good rule of thumb, but certainly not a deal breaker, is to have a net income of about $50,000 to make the tax savings be greater than the additional cost of separate tax returns and payroll expenses. I work with business that have losses and still are S Corps. The $50K income isn’t a requirement, it’s just sort of a break even point on costs.

2. Separate Employer Identification Number (EIN) and bank account. If your business is set up as an LLC, you should have a separate EIN and a bank account for your business already. I’m always surprised by people who skip this step, but it’s important. You can get an EIN number for free, online. It takes about 5 minutes.

Learn more here.

And you really need a separate bank account. You don’t want to co-mingle your business funds with your personal money.

3. Discipline to make monthly payroll deposits and quarterly reporting. One of the requirements of an S Corporation is that the owner has to pay him or herself a reasonable wage. That means, even if nobody else works for you, you still need to write yourself a paycheck and pay yourself like an employee. If you’re already making your quarterly estimated tax payments–you’re probably able to handle doing a payroll. If you’re scrambling every year, you can’t keep on schedule etc, then I say don’t do the S corp. Not being up to date on your estimated payments can be a problem, but the IRS can get really nasty if you’re behind on payroll tax deposits.

If you have no discipline, and your business easily has enough revenue to handle the payments–and still want to do the S Corp, then pay the extra money to hire a payroll company to do it for you.

Setting a reasonable wage is usually the most difficult thing to determine. You want to go by what a person in your line of work would get normally get paid, that’s not always easy to figure. You should probably have your wage be at least 1/3 of your net income unless you can document that people in your line of work usually make less.

Now, these are just my guidelines. There’s really no “set in stone” criteria for S Corp status. And really, before you make any change to the status of your business, what you really should do is run the numbers. Sit down with your tax professional and – using the most recent tax return – run the business numbers as if you were an S Corp, a C Corp, and as a sole proprietor. Don’t forget to include the costs of your payroll taxes when running the numbers.

Everybody’s situation is a little different. Compare your numbers side by see to see if changing to an S Corporation makes sense for your small business. That’s really the best way to tell.

Posted on December 10, 2013May 31, 2016 by Jan Roberg

Tax Planning Strategy for High Income Earners with S-Corporations

Are you a high income individual with an S-Corporation? Photo by Jacob Bøtter at Flickr.com

Whenever I’m talking about tax strategies for high income earners with my clients they always ask, “What do you mean by high income?” If I’m talking to a person face to face and I bring up tax strategies for high income earners, I mean the person I‘m talking to. I wouldn’t bring it up otherwise. Since you happen to be reading this on the internet, for this post I generally mean people with incomes over $200,000.

Here’s what’s up: The new Medicare tax on investment income (or Obamacare tax, Net Investment Income tax, Healthcare tax, or whatever you want to call it) also taxes your S Corporation profits. Let that sink in for a minute. S Corporation profits will be counted in the same category as interest and dividends and capital gains for the 3.8% Medicare investment tax.

Let me give you an example of how this could affect you: Let’s say you’re single and you have wages of $150,000 and S-Corp profits of $200,000 for a total of $350,000 in Adjusted Gross Income.

To figure the medicare investment tax you’d take $350,000 – 200,000 (the base) = $150,000. You have $200,000 in investment income, you’re only going to pay the 3.8% on whatever is over the base so your Medicare investment tax is 3.8% time $150,000 which equals $5,700.

At $150,000 on wages, you’ve already maxed out the Social Security withholding that you were subject to so additional Social Security tax doesn’t affect this example.

Now let’s compare your investment Medicare tax with your wage Medicare tax. Withholding on your wages is 1.45%, plus the employer contribution on your wages is an additional 1.45%–so as the owner/employee of your S-Corp you’re paying 2.9% Medicare taxes on your wages. Once you cross the $200,000 wage point, there’s an additional 0.9% Medicare wage tax bringing the Medicare wage tax to 3.8%. That’s the same rate as you would pay with the Medicare Investment tax.

It used to be that one of the benefits of being an S-Corporation was that you didn’t pay the extra 2.9% (now 3.8%) Medicare tax. You’re losing the savings benefit you used to have.

Now this doesn’t affect everybody. If your S-Corp income is lower, this might not matter to you. That’s why you have to do some comparisons.

So, a really important question for you is going to be–is your S Corporation still the right business structure for you? For some people, the answer will be yes. For others, it might be time to convert to a regular C Corporation, a Sole Proprietorship, or Partnership.

The Obamacare tax will be reported on Form 8690 and added to your 1040 personal income tax return.

How can you tell? This year, more than any other year, you want to get your taxes done on time. Run the numbers all the ways that you’re thinking about. Be sure to figure things based on the changes you’d make if you had a different business structure. Then you can make an informed decision based on the numbers.

Remember, your corporation taxes are due by March 15^th. If you want to revoke your S-Corp election for 2014, you have to do that by March 15^th of 2014 otherwise it will be too late. Of course, you can revoke your S-Corp election and still file an extension for your 2013 taxes. But the smart thing is to run your numbers before you revoke the election–because you still might be better off keeping your S-Corp. For many companies, changing your corporate status will give you no benefit–for many others it will. That’s why it’s so important to make the decision with your eyes wide open and with all the facts in your hand.

Posted on December 9, 2011November 29, 2016 by Jan Roberg

Sub-S Corp Year End Tax Tips

As the year comes to a close, make sure you do everything you can to reduce your tax liability.

Updated for 2016

You read a lot of news stories about year-end tax tips, but you don’t see a lot of things specifically targeted at Sub-S Corporations, and there’s nothing out there for the single owner S Corporation. It’s kind of sad because most people with Sub-S Corps are set up that way for the tax advantage. If you own a Sub-Chapter S Corporation, then you need to make sure that you maximize your deductions. These tips are especially for you:

First, and most importantly, if you’ve got a profit this year, you want to make sure that you are paying yourself some type of payroll. This is one of the most common mistakes that S Corps make. The point of having an S Corp is to protect some of your income from self employment taxes. (Notice I said some, you can’t protect yourself from all self employment tax.) S-Corporaton owners need to pay themselves a salary. In the early years of a business, there’s often a loss and the salary isn’t important, but once the business is in the profit side, the owner should be paying a wage that is commensurate with what he or she’d be earning if he worked the same job for someone else. If you don’t do this, the IRS can come back and assess self-employment tax on 100% of your S corp profit. That would completely defeat the whole purpose of being an S Corp, so that’s the first thing you want to handle.

Reimburse yourself for your employee expenses: Write yourself an expense report and have the S Corp write you a check. For example: let’s say you took a business trip for a convention and your travel expenses cost $1000. You paid it out of your own pocket because it was easier at the time and you just figured that you’d write it off on your taxes later. But that’s a stinky idea. Here’s why:

Even though you are the owner of the business, you are also an employee. As an employee of the S corp, you would put the $1000 travel cost on your schedule A as an employee business expense. When you do it that way, the expense would be subject to the 2% limitation rules. Meaning, you can only deduct expenses that are over 2% of your adjusted gross income. The higher your income, the smaller the deduction you get to claim. If you pay Alternative Minimum Tax, or don’t itemize your deductions, you could even get a zero tax benefit from putting it on your schedule A. So putting the expense on your schedule A gives you a much smaller tax benefit than if it’s on your S Corp return.

When you do an expense report, and reimburse yourself through the business you get 100% of the allowable business deduction. Isn’t that much better?

Next up: Pay your health insurance through your S Corp: This is a little convoluted, but stick with me. If you claim this deduction, you want to do it right. As an employee of your S Corp, you can’t claim the self-employed health insurance deduction like you could as a sole proprietor. Your health insurance would go on your schedule A subject to a 10% limitation before anything could be deducted (for most people that’s a zero deduction.) We don’t like zero deductions! So you have to do the S-Corp health insurance dance. It goes like this:

Your S Corp pays your health insurance, then it comes to you as a taxable fringe benefit. When you do it this way you get to deduct the cost of your health insurance on page 1 of your tax return (just like a sole proprietor)—a much better place to put a deduction. You do not pay FICA on your health insurance.

So let’s say your wages from your S corp are $10,000 and your health insurance is $5,000. In box 1 of your W2, it would say wages $15,000. In boxes 3 and 5 – the Social security and medicare wages, it would say $10,000. You would then deduct the $5,000 that you paid in health insurance under the self employed health insurance line. (Line 29 in the 2015 return.) Yes, I realize that this sounds like a cockamamie way to do the accounting for your health insurance–but those are the IRS rules. ‘Nuf said, right? And while I realize that this sounds crazy, that’s really how you do it.

Another expense you don’t want to miss out on is to reimburse yourself for your home office deduction: It’s hard to claim a home office deduction on a Sub-S corporation. Like other employee expenses, it would go on your Schedule A and be subject to the 2% limitation rules like any other employee business expense. Many accountants won’t even touch a home office for a Sub-S Corporation.

Some people try to charge rent to their S Corps for their home office, but that’s just moving your income from one taxable entity to another so you don’t really save anything on you taxes that way either..

What you want to do is reimburse yourself for your home office deduction in a fully accountable plan. That’s a phrase that you want to remember: fully accountable plan. Prepare a form 8829 Home Office form like you were doing it for a sole proprietorship and use that report to determine how much you should reimburse yourself for your home office. Remember, it’s a reimbursement, not a rent payment. It reduces taxable income to the company, but it is not taxable to you because you have “accounted” for the expenses. For more information about home office deductions, you might want to read this post: How to Boost Your Home Office Deduction

If you’re interest in more year end tax tips, you might also want to check out: Year End Tax Tips for Tiny Business Owners.