Should I own an S-Corp to save taxes?
How many S-Corps should you have? Is one enough? Multiple? Or should you skip the s-corp altogether? I will only focus on the taxes and retirement savings when it comes to the s-corp and not any legal or shareholder benefits.
S-Corporations are great for small business taxes, but you need to know how those taxes work to make the most of your s-corp. I will talk about two separate taxable incomes; W-2 income and distributions.
There are two sides to FICA taxes; social security and Medicare taxes. The W-2 income will have social security and medicare taxes for both the employee and employer. It breaks down to 6.2% for social security and 1.45% for medicare. Both employer and employee each pay this amount bringing the total to 15.3%. Social security is only taxed on the first $147,000 for 2022.
Distributions are not subject to FICA taxes.
So, for example, let's say your company was set up not as an s-corp but as an LLC, and you had a net profit of $100,000. You would pay FICA and federal income taxes on the entire amount. However, let's say you had the same business and paid yourself a $50,000 salary and took $50,000 in distributions. You would not pay any FICA on the $50,000 distribution. Huge savings.
Additionally, let's now say that you also want to save $50,000 on your retirement plan. You could open a Solo 401k and get most of it pre-tax. You could potentially save $19,500 pre-tax and make a $12,500 profit-sharing contribution reducing your W-2 federally taxable income to $30,500 and your distribution to $38,500.
Your total compensation was the same, but now you have a much lower tax bill.
While you could still save a similar amount using an LLC, the S-corp distribution effectively saves you 15.3% in FICA taxes on the $38,500.
I like using the s-corp, but there is a catch. It's the employer's side of taxes. Suppose you have multiple S-corporations and earn a total income above $147,000. You don't necessarily get capped. If you have two companies, each paying you $100,000 for a total of $200,000, you'll pay social security and medicare taxes on all of it on the employer side. If you are taxed as an LLC, the amounts will aggregate and cap out at $147,000 for employment taxes.