The tax code is very complicated with thousands of rules and exceptions. Because of that, there is no such thing as a one size fits all solution. That being said, if you are a small business owner or an independent contractor (meaning you get a 1099-MISC) you should look into the benefits of an S Corporation.
Benefit One: Payroll Tax Savings
Ordinary income (that’s the type of income you are receiving as an independent contractor and small business owner) is subject to a 15.3% self employment tax (aka social security and medicare tax, payroll tax). If you have $1,000 of taxable income, then your self-employment tax is $153. Then you pay your income tax on top of that.
By running your income through an S Corporation, you can minimize this tax. The reason is because the net income that is reported to you on your personal tax return through the S Corporation K-1 is not subject to self employment tax.
You are required to pay a reasonable officer wage which is subject to self employment tax. However, the reasonable wage is rarely 100% of the businesses taxable income. This means there is always going to be tax savings by using the S Corporation. (Assuming you have taxable income).
Benefit Two: Lower Audit Risk
I can only speak on experience here. In general, those who file business income on a Schedule C on their 1040 personal return, tend to be audited more frequently than an S Corporation business return. I do not have any concrete reasoning as to why this is. But statistically I have seen this evidenced through my own experience.
Benefit Three: Legal Separation
If one is not using an S Corporation, the most common choices are either a sole proprietor or a single member LLC. As a sole proprietor, you are your business. This means all your assets are your businesses assets and all your business assets are your assets and all your business activities are your personal activities. A lawsuit against your business is a lawsuit against you.
While a single member LLC is technically an entity, most of my attorney colleagues agree that more and more judges are treating a single member LLC like a sole proprietor in lawsuit scenarios.
The S Corporation is a much stronger separation than these other two options. (Please note, that I am not an attorney and I’m not offering any legal advice here.)
Here we have only mentioned 3 of the benefits of an S Corporation. If you are a small business owner or an independent contractor, you should consider seeking professional advice on whether an S Corporation could be right for you.