In this episode of Profits + Prosecco Podcast, we are going to be talking all about S Corps. I want to share more about exactly what an S Corp is, how to determine when it’s right for you, how to get yourself established so it’s easy to become an S Corp, as well as understand how it can save you money.
But before we dive right in, welcome to the Profits + Prosecco Podcast! I’m your host, Katie Ferro, CPA, reformed rule follower, creator of Booked Out Bookkeeper, mom to 3 little ones, and Kajabi enthusiast.
This podcast is for entrepreneurs who desire to change their life through their profitable business, and for bookkeepers and accountants who want to escape the 9-5 and start a simple scalable bookkeeping business like I did.
Bookkeeping increases profits and profits change lives. So pop some bubbles and let me show you how!
In this episode, we are going to dive into S Corps and everything you need to know about them. And for even more juicy details, listen to ALL of episode 3 of the Profits + Prosecco Podcast on your fave streaming platform.
My general recommendation when you are in business by yourself is to register your business as an LLC in your state. The reason for that is because firstly, you get a legal separation. You are also able to provide a business name when you do anything under your business, for example signing a lease or hiring an employee. Overall, you look more legitimate. With this legitimacy, you take yourself more seriously. By not getting an LLC, it can be a mindset issue. This could mean you still don’t take your business seriously enough and hold limiting beliefs. By coming up with the money and making your business an LLC, it can truly do wonders when it comes to how you show up.
Another reason for this is that transitioning to an S Corp will be significantly smoother of a process if you already have an LLC set up. When it does come to getting your LLC, register it in your state. You can go to your state’s secretary of state website. Look for how to establish an LLC and if you do need help, you can contact someone to assist you with it. Overall it is a simple form, just make sure if you are a solopreneur you list yourself as the member or owner. Avoid putting your spouse or husband, this means you will be a partnership and overcomplicate things when it doesn’t need to be. When you are profiting enough to justify being an S Corp, all you have to do is file a form with the IRS called an S Election. I recommend doing that once your profit reaches at least $50,000. This is when you should call in a CPA to talk about whether this is a good time for you and to file the form.
I want to break down the differences between an LLC without an S Election and an LLC that is now an S Corp so you can see the differences and how it starts to save you money once you start profiting enough. Like I mentioned above, if you don’t get an LLC or you do and you’re the only owner that does not make an S Election, your taxes will not change. You will be considered a sole proprietor of the IRS and file one tax return. This will be your personal tax return, reporting your business activity under a Schedule C. If you are new to business, when you are a sole proprietor, this means you are paying income tax on the profit at your standard rate, whatever that is for you. You are also paying self-employment tax on all your business profit. Self-employment tax is 15.3% which can add up as you begin to profit more.
When you are an S Corp, things change. You are an LLC in both cases, but if you make the S Election, your business is an S Corp. This is now treated as a separate entity where you file two tax returns. One for business and one for personal. When you separate your business and personal, the IRS demands you to pay yourself as an employee through payroll with paychecks and payroll returns. You have more tax responsibilities when you are an S Corp, I never advise you to do your own S Corp return. It makes sense to have your tax preparer handle both personal and business as well as help with payroll. These things come along with costs, which is why I don't recommend everyone to become an S Corp right away. Instead, become established first with an LLC so you can switch to S Corp when it makes sense.
With self-employment tax being 15.3% on top of your income tax, this is designed to replace payroll tax. If you have ever had a regular W-2 job and you’re not a contractor, you may or may not have noticed that on your paycheck, you get withholding taken out as well as FICA. FICA is your medicare and social security coming out of your check and never gets refunded to you. This is the payroll tax, which is 7.65% of your salary. Your employer was also paying 7.65% on behalf of your wages to the IRS. The government is getting 15.3% combined, half from you and half from your employer. When you are an S Corp, you no longer have self-employment tax which is why they want you to pay yourself a salary.
Here’s where you save money, you don’t need to pay yourself a salary equal to your profits. S Corps can pay the owner a salary that is LESS than the profit, in this scenario you save 15.3% on the profit you are not paying yourself as a salary. For example, let’s say in one scenario you are an LLC without an S Election. You have $200,000 worth of profit. If you're NOT an S Corp, you will pay self-employment tax on $200,000 which is $30,600. In another scenario, if you are an S Corp and your business profits $200,000, you pay yourself a salary of $120,000. Your business is left with $80,000 of profit. You have paid yourself a salary of $120,000. That $120,000 salary is going to be subject to payroll tax at a combined 15.3% which is about $18,360. The $80,000 profit is where you will save. You are saving about $12,000 with S Corp when you look at these two scenarios.
Questions you want to ask yourself to determine if becoming an S Corp is the right decision now include: Does the tax savings of being an S Corp cover the costs of being an S Corp? These costs include the tax prep for S Corp and your payroll. At about $50,000 profit you are close to breaking even here. Beyond that, you can start to save a lot of money. At $50,000 worth of profit, I recommend you meet with a CPA and have a conversation about whether being an S Corp makes sense. You want to ask them when you should start payroll and make the S Election. An S Corp may not make sense for you if you are profiting below $50,000 because you have to file two tax returns and you can’t file a business return yourself.
If you are an S Corp and decide it makes sense, remember that you have to pay yourself a salary. You are obligated to pay yourself a salary. If you are an owner and not taking a salary, it’s the number one way to get audited. There is a line on the tax return that says officers compensation, if that says zero, you will get examined. You don’t want that because then they can decide all your profits should’ve been wages. This will result in paying payroll tax and self-employment tax, so it’ll be a huge chunk at once. Instead focus on getting above $50,000 in profit, making the S Election, have an accountant help you, and get started on payroll. The payroll will help you stay out of trouble with the IRS and pay in the amount of tax you need.
To recap the highlights here, you can save money in taxes by being an S Corp once you are profiting $50,000 and above. To become an S Corp, you have to be an LLC first. I recommend that you establish your LLC now if you have not already. Then you can get your EIN and get your business bank account. Do your books, keep an eye on profits, when you are at about $50,000 have a conversation with your CPA about transitioning to S Corp. By this point, you will also need to already be running payroll!
To get connected with an amazing payroll representative as you find yourself wanting to become an S Corp or bringing on employees, be sure to visit https://www.katieferro.com/payroll
Don’t forget to tune into episode 3 of the Profits + Prosecco Podcast. Thank you so much for listening to Profits + Prosecco podcast. I know this episode has helped you see how profitable businesses change lives. If you enjoyed the episode, please take a second to rate and review. Each review helps us reach and inspire more entrepreneurs and bookkeepers just like you.
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I'm a licensed CPA with 10 years of tax and accounting experience, fellow entrepreneur, & mama of three little ones.
I'm highly passionate about helping business owners increase their profits so they can live out their purpose long-term and make serious changes in their lives.
I do this by taking your bookkeeping off your plate, helping you plan for taxes, increase your profits, understand what's working in your business, and allowing you to get back to your true zone of genius.
BUT THAT LEADS TO...
💰Getting hit with hefty penalties and interest
⌛️Wasting your valuable time
🤯Stressing out over handling the mishap
🥴Lacking insight on how your business is doing and thus making poor business decisions.