If you own a small business, you might be throwing away thousands of dollars every year by not electing S Corporation (S-Corp) status. The best part? It’s 100% legal and IRS-approved—yet so many business owners fail to take advantage.
Most small business owners operate as sole proprietors or LLCs, unaware that these structures force them to pay significant self-employment taxes. But using an S-Corp, you can reduce your tax burden and keep more money in your pocket-legally. Let’s break down exactly how this works, whether it’s the right move for you, and how to set it up properly.
How You’re Overpaying in Taxes Right Now
If your business is structured as a sole proprietorship or a single-member LLC disregarded entity, you’re paying self-employment tax on 100% of your profits. Here’s why that’s a problem:
- Self-employment tax = 15.3% (12.4% for Social Security + 2.9% for Medicare).
- This tax applies before you even calculate income tax.
- You’re paying both the employer and employee share of Social Security and Medicare taxes.
Example: The True Cost of Self-Employment Taxes
Let’s say your business earns $100,000 in profit in a year. Here’s how much you’ll pay under different structures:
Business Structure | Self-Employment Tax | Income Tax | Total Taxes Paid |
|---|---|---|---|
Sole Proprietor/LLC | $15,300 | ~$20,000 (depends on bracket) | ~$35,300 |
S-Corp (Salary: $50K, Distribution: $50K) | $7,650 | ~$20,000 (depends on bracket) | ~$27,650 |
That’s a savings of $7,650 just by electing S-Corp status!
If your business earns $150K+, your savings can easily exceed $10,000 per year.
How an S-Corp Saves You Money
An S-Corp helps you save on taxes by splitting your income into two parts:
✅ A Reasonable Salary – This portion is subject to payroll taxes.
✅ Distributions – NOT subject to self-employment tax.
Breaking Down the Tax Savings
Here’s how an S-Corp owner reduces their tax burden:
- Pay yourself a reasonable salary – The IRS requires that S-Corp owners pay themselves a fair wage based on industry standards.
- Take the remaining profit as distributions – Any income above your salary is treated as a distribution, which is not subject to self-employment tax.
- Lower total taxes owed – By reducing taxable wages, you pay less in Social Security & Medicare taxes while still benefiting from pass-through taxation.
Example: How the Savings Add Up
Imagine you own a marketing business making $120,000 in net profit:
- As a sole proprietor, you pay $18,360 in self-employment taxes.
- As an S-Corp, you set a $60,000 salary, leaving $60,000 as distributions.
- Your payroll tax is now $9,180 instead of $18,360.
- That’s an annual tax savings of $9,180!
Multiply that over five years, and you’ve saved nearly $50,000—money that can be reinvested into your business or used for personal wealth building.
Who Should Consider an S-Corp?
An S-Corp isn’t right for everyone, but it’s a great option if:
✔️ Your business earns at least $50,000–$60,000 in net profit.
✔️ You don’t need to reinvest all profits back into the business.
✔️ You’re comfortable with running payroll and some extra paperwork.
✔️ You want to legally minimize taxes while staying compliant.
Who Should NOT Choose an S-Corp?
An S-Corp may not be the best fit if:
❌ You make less than $50,000 in net profit (tax savings won’t justify extra paperwork).
❌ You reinvest most profits into the business (instead of taking distributions).
❌ You’re not ready to run payroll (S-Corps require regular paychecks, W-2s, and tax filings).
If you’re unsure, consult with a tax professional to determine if the S-Corp election makes sense for your business.
How to Set Up an S-Corp in 5 Steps
If you’ve decided that an S-Corp is right for you, here’s how to set it up:
Step 1: Form an LLC (If You Haven’t Already)
- Most small business owners first register as an LLC before electing S-Corp status.
- LLCs provide legal liability protection and flexibility.
Step 2: File IRS Form 2553 to Elect S-Corp Status
- This form must be filed within 75 days of starting your business or by March 15th of the tax year.
- You can backdate the election if needed (this is trick, consult a tax expert).
Step 3: Set Up Payroll & Pay Yourself a Reasonable Salary
- The IRS requires S-Corp owners to take a reasonable salary before distributions.
- Use payroll software to stay compliant.
- You’ll also need to withhold income taxes, Social Security, and Medicare from each paycheck.
Step 4: Separate Business & Personal Finances
- Open a business bank account to track income and expenses.
- Use bookkeeping software for financial records.
Step 5: File S-Corp Taxes (Form 1120-S) Annually
- S-Corps file an informational return (Form 1120-S) instead of a personal Schedule C.
- Owners receive a K-1 statement to report profits on their personal tax return.
Important Note: Even though S-Corps avoid self-employment tax, you still pay federal & state income tax on all earnings. Make sure to set aside funds for tax season!
Final Thoughts: Stop Overpaying the IRS!
Every year you delay switching to an S-Corp, you’re giving away thousands to the IRS unnecessarily. If your business meets the criteria, it’s time to stop overpaying and start keeping more of what you earn.
🚀 Need help setting up your S-Corp? Tax Rescue CPA makes the process easy! Contact us today and start saving!
“Who’s Saving You Taxes?” – Tax Rescue CPA
