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Set Up an S Corporation to Reduce Self-Employment Taxes
Small business owners should consider whether or not it makes sense to set up an S-Corporation as a way of reducing total taxes paid. If your business currently operates as an LLC, a partnership or a sole proprietorship, then your profits are subject to self-employment taxes. As an S Corporation, only your salary is subject to self-employment taxes. Here are the details:
- The first $102,000 (CY 2008 number) of salary that a person earns is subject to self-employment taxes of 15.3%. Half of this is paid by the employer and half by the employee. Of course, if you own your own business, then you are both employer and employee.
- Salary in excess of $102,000 is subject to the Medicare tax rate of 2.9%. Again, half is paid by the employer and half by the employee.
- If you operate as an LLC, a partnership or a sole proprietorship, then your profits are treated as salary, meaning you pay taxes per the above on all your profits.
- If you operate as an S Corporation, then you only pay the above taxes on money you take as salary.
Many small businesses are started as LLCs, partnerships or sole proprietorships because of the ease of setting these businesses up. This often makes sense, but switching to an S Corporation is not that complicated, so beware of the above and make the switch when the time is right.
Finally, it is important to note that you are required to take "reasonable" compensation as salary when you operate as an S Corporation. Talk to your accountant about what constitutes "reasonable" salary for your particular situation.
