A Guide to S-Corporations
- Jerrod Aud
- Oct 28
- 4 min read
Step one in forming your business is understanding the entity structure that best suits your plans now & in the future.
Schedule C
Many start this way because it's easy, and almost anyone can do it. This entity files on the individual tax return typically reporting through the owner's social. Things become even easier when you try to setup a bank account and find out it's as easy as a breeze in the trees. It's so quick & easy that getting settled into this type of entity structure may make you want to stop there. But net income (income after all expense) is subject to self-employment taxes (SE Taxes) of 15.3%!
Self-employment Tax
This is tax that people who work for themselves have to pay. For people who have W-2 jobs they pay into payroll taxes (Social Security & Medicare) but at half the rate of a small business owner. For a Schedule C business owner SE tax is the tax that they will pay before we even get to their effective tax rate on the return.
Which makes sense, because even if I'm a W-2 employee I have to pay half into payroll taxes, and my employer pays the other half- which both account to 15.3% (magic number.) To shorten the long, there are these things called Social Security & Medicare, and Uncle Sam makes sure your share is contributed to each.
Partnerships
Ordinary business income from partnerships in which the partner actively participates is subject to self-employment tax just like the Schedule C. However, limited or passive investors in a partnership are not subject to SE taxes. But for these purposes we're talking about owners who are actively working their business.
C-Corps
What is this, 1987? Moving on.
So, what's the play here?
S Corporations
S Corporations are a great option for businesses earning a decent profit and plan to going forward. Unlike a Schedule C, which files on the individual return, the S Corporation is its own entity. It files its own return and does not pay self-employment taxes on net business income. Instead, the portion that ends up being subject to payroll taxes is what is paid out through Officer's Compensation (W-2). As a result, shareholders of a S Corporation are able to distribute a portion of the net profit as shareholder distributions NOT subject to the tax 15.3% tax.
Officer's Compensation
S-Corporations must determine a reasonable wage to pay participating officers of the business. And just picking a number is dangerous because underpaying or not paying wages at all come with consequences. Checkout my article on required officer's compensation, HERE.
Quick Breakdown
A company that makes $100,000 in net business income can expect to pay $15,300 in self-employment taxes as a Schedule C.
The same business that operates as an S-Corporation may only pay 30-40% of that in wages subject to the tax. That results in a payroll tax (SE tax) savings of $8,000-$10,000.
Cost to Operate
The reason everyone under the sun isn’t a S Corporation is because of the additional costs to operate. First, the business must pay a reasonable compensation to officers which means wages.
The entity will be required to obtain an EIN (if it doesn’t already have one) and make the S Corp Election with the Internal Revenue Service. A separate bank account is setup using the EIN of the entity as owner, and formal bookkeeping is needed. Last, is a completely separate tax return that is now required for the business that stands alone for filing.
Get Professional Help
Sparked your interest? Instead of becoming overwhelmed this is the perfect opportunity to bring in a Tax & Accounting Professional. I typically look for a net business income of around $35,000-$40,000 and the future income earnings expectations before I begin to recommend the S-Corporation.
Deadline
LLC's have 75 days from the date of formation to make the S-Corp Election. If this time has passed specific procedures must be reference in qualifying for a retroactive election. However, the number of days since the formation of the LLC must not have surpassed 3 years 75 days.
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