Benefits of Being Taxed as an S-Corp (even if you aren’t one)

Many solo entrepreneurs begin their business as a side hustle and don’t think about taxes. But as your business revenue increases, you’ll want to be sure you aren’t paying more in taxes than you need to. If your business is an LLC, you can file taxes as an S corporation to save on self-employment taxes. Read on to find out how.

A limited liability company (LLC) is a legal entity that your business registered with the State Corporation Commission when you first started the business. Most business owners choose this entity as a starting point because it offers some of the protections of a corporation, like limited liability (protecting personal assets from business debts), but is easier to form and operate.

By default, a single-owner LLC Is taxed as a sole proprietor. This means the owner is considered self-employed and reports business income and expenses on their personal tax returns. Any profit is subject to federal, state, and self-employment (Medicare and Social Security) tax. In 2021, the self-employment tax rate is 15.3% (12.4% for Social Security and 2.9% for Medicare) and you’ll pay this on all your profits until you reach the annual maximum ($142,800 in 2021).

For example, if your business had profits of $100,000, and you are taxed as a sole proprietor, you would pay self-employment tax of $15,300 (15.3% of $100,000), plus income tax based on your tax bracket and filing status.

By filing IRS Form 2553, you can ask the IRS to tax your LLC business as an S corporation. When you do this, you become an employee of the business and pay yourself through regular payroll. Your salary will be subject to Medicare and Social Security tax, but company profits above your salary will not be subject to self-employment tax. When setting your salary, the IRS wants it to be a reasonable salary for someone in your industry, with your level of experience, in your geographic area. You can’t pick a lower than normal salary number just to save on taxes.

For example, if a reasonable salary in your area is $70,000 and your business had profits of $100,000, filing as an S-corporation would mean you pay Medicare and Social Security tax on $70,000 instead of $100,000: $10,710 vs. $15,300. (Plus income taxes on both your salary and profit.)

There are some extra administrative costs when filing as an S-corporation, but the tax savings more than make up for that expense. If you still aren’t sure if filing as an S corporation is right for your company, reach out to your SBDC Advisor and check out the IRS small business tax center.