Many of you are business owners, so you have probably heard about S Corps and the tax benefits that come from being an LLC taxed as an S Corp. However, you have only heard about half of the story, so I want to help educate you on it.
One of the main benefits (the only only you have probably heard of and thought about) of S Corps is saving on self-employment taxes. Let me show you how that works:
Let’s say you have a business with $150,000 in profit. If you stay taxed as a partnership all $150,000 would be taxed at the state and federal level, and then you would have self employment taxes at 15.3% on all the $150,000.
This means you would pay around $23,000 in self employment taxes. Obviously part is deductible, but let’s keep it simple for this post’s sake. It is important to note that in 2023, the 15.3% only continues until you reach $160,200 ($168,600 for 2024). Once you make that much, you only have to pay 2.9% for Medicare and then an additional .9% at $200,000 of earnings for a single filer.
However, if you chose to be an LLC taxed as an S Corp, you could then pay yourself a reasonable salary, call it $85,000 which would be subject to all the taxes above. Then pay yourself the other $65,000 through distributions. This part, the profit, would avoid self employment taxes since you do not pay self employment taxes on the profits. Meaning you would be saving $65,000 x 15.3% = $9,945 by doing this strategy.
Sounds great right?
It is nice.
And you also would get a 20% QBI (qualified business income) deduction on the profit, that $65,000 (which would be lower than the first example since the entire amount paid out was profit).
However, many hear this and think you should pay a reasonable salary and then take all the rest in distributions no matter how much income you have.
But this is wrong!
As you can see, the QBI deduction starts to phase out at $340,100 (married filing jointly) and then at $440,000 of taxable income becomes 50% of W2 wages. Meaning if someone has let’s say $1,000,000 in profit and chose to do $100,000 salary and $900,000 distributions, they would only get a $50k QBI deduction (and maybe being paying too low of a reasonable salary) vs someone who chose to to do a $275,000 salary who would get a $137,500 deduction.
And on top of that, the first person would only get to do $22,500 on the employer side for a solo 401(k) vs person two could do up to the max of $43,500 (since on the employer side you can only contribute 25% of W2 wages).
You may be thinking if you do pay yourself more, then you will have 15.3% more on self employment taxes up to $160,200. Then once you reach that number, 2.9% on the rest of your salary. And then .9% additional Medicare tax may also apply if your net earnings from self-employment exceeds $200,000 as a single filer ($250,000 if you’re filing jointly). But even when adding those extra costs in, the higher salary may make a lot of sense.
The goal here is to educate you more on tax planning, QBI, why your salary matters, etc. We have brought on a few clients recently and partnered with their CPA on this, and the tax savings are massive.
You need someone on your team being proactive and doing this planning for you as you build your business.
The end of the year is the time to really nail this down based on how you have done!
Disclaimer: None of this should be seen as advice. This is all for informational purposes. Consult your legal, tax , and financial team before making any changes to your financial plan.
Financial Advisor