When talking about business entities and the best tax structures for small businesses, the S Corporation comes up a lot. In general, it’s the best structure for small businesses. So, let’s get into all the important stuff about S Corp taxes and setup.
Entities, or tax structures, are the S-Corp, LLC, Partnership, Corporation, Sole Proprietor, etc. When it comes to the best entity selection for you, you want to pick the entity that matches the type of income you’re making. Because in typical IRS fashion, the tax code doesn’t just say, oh, you made a dollar, that’s your income. They’ll say, you made a dollar of ordinary income or you made a dollar of self-employment income or you made a dollar of passive income.
Dreaded Self-Employment Tax
So, if you have a business that sells products or services, that type of income is considered ordinary income. Ordinary income has this fun little tax tied to it called self-employment tax. At the writing of this blog, it’s a 15.3% self-employment tax. It’s called self-employment tax because the employer, which is you, pays 7.65%, and the employee, which is you when you’re self-employed, also pays 7.65%. That adds up to a 15.3% tax rate on top of your income tax.
If I made money and say, I’m in the 15% tax bracket, but the money I made is self-employment income, and I have the wrong tax structure, I could easily be paying 30% tax instead of 15% tax. The S Corp is a great entity that helps us reduce that self-employment tax. It doesn’t get you out of all of it, but significantly lowers your tax obligation.
S Corp Taxes are Less
We have a lot of blogs that go into a lot more detail when it comes to how that 15% works and this blog in particular about the top business entities and what some of the compliance things are that you need to do to make sure you don’t get in trouble with the IRS. But, for the sake of S Corp taxes, it’s simple math.
If you have a business that sells products or services that generates ordinary income, the S Corp will help you reduce the self-employment tax portion. See, simple math.
That’s not to say it always works out that way. That’s why you need to choose the right structure. But in general, and I mean very general, for every thousand dollars you make in an S corporation, you’re going to save about a hundred bucks in self-employment tax. Again, that’s a general statement. It might not be the exact number for you, but there is a tax savings that happens.
S Corp Setup
When it comes to the question of how to set up an S Corp, this is where it gets fun. No state will allow you to set up an S Corp, because it is a tax status only. That means as far as the IRS is concerned, yes, there’s an S Corp.
With the state you’re going to set up an LLC or you’re going to set up a corporation with an Inc at the end of the name. So, you have to set up the entity with the state. Then you fill out Form 2553 with the IRS. It’s two pages. Well, it’s three, but you only fill out the two pages. Then you send those two pages to the IRS, which basically says, hey, I have this entity that I set up over here with this state, please treat it like an S corporation. So, it’s really easy. Form 2553 is only going to ask for information about your business which is very easy to have. It’s not complicated, but you send that off. That’s how you set up an S corporation.
To summarize, if you’re earning ordinary income, you really should consider if an S corporation makes sense as your tax structure. No one likes overpaying on taxes. By setting up the right entity, you will reduce unnecessary taxes.
Further reduce your S Corp taxes by using all the strategies in our free Big Sexy Beefy Tax Crushing Packet.
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