There are many reasons why the owners of an LLC or corporation would choose to have their company receive S-corporation tax treatment. Corporations might want to take advantage of the pass-through taxation (shareholders must still report dividends on personal income tax returns). Members (owners) of an LLC might also be attracted to the S-corporation tax treatment due to recent tax reforms. Depending on your reason for electing S-corporation status for your company, there are a variety of ways to go about saving taxes.
Pay Yourself Through Dividends
Owners of companies that receive S-corporation tax treatment may receive compensation through wages AND dividends. One distinct advantage of paying yourself, as an owner, primarily through dividends is the opportunity to avoid a sizable amount of employment taxes. FICA taxes (Social Security and Medicare) must be paid on wages, but not dividends. So, a relatively simple way of saving money on FICA taxes is to give yourself the lowest reasonable salary while receiving the majority of your pay through dividends. LLC members, on the other hand, may not be regarded as employees of the business.
What is a “Reasonable” Salary?
We emphasize the word “reasonable” because officers of S-corporations may not completely avoid paying employment taxes. An S-corporation officer must take a salary that is “reasonable” in proportion to the services rendered to the business. In other words, you cannot take an annual salary of $1 if you do any work at all at your S-corporation.
If, for example, you wanted to keep up with your $80,000-per-year salary that you were making as a sole proprietor, you could pay yourself $35,000 in S-corporation wages and the rest ($45,000) in dividends. This would dramatically reduce your taxable income. You can decrease the taxable income even more if a portion of your wages are health insurance premiums paid by your S-corp. Going back to the example above, your income subject to employment taxes would decrease to $30,000 if your health insurance premiums total $5,000 per year.
So, what is the lowest “reasonable” salary you can pay yourself as an officer of an S-corporation? That depends on many factors, including your training and education, compensation agreements, and wages for similar services at comparable businesses. Our firm conducts and has access to reasonable compensation studies to help clients determine the proper amount to take home in wages.
Accountable Plans
Although employees are no longer able to deduct out-of-pocket business expenses on their personal income tax returns, you could be reimbursed for these costs if you set up an accountable plan for your S-corporation. For more on this tax-savings strategy, please reference one of our previous blogs.
Don’t Forget About QBI Deductions
As long as you have taxable income at or less than $164,900 (for single filers) or $329,800 for joint filers, you can reduce that taxable income by 20 percent of your business taxable income. While this deduction is also available to sole proprietors and for other business entities, you may be able to maximize the deduction through an S-corporation.
Is an S-Corporation the Right Choice For Your Business?
With all the attractive components of LLCs, many LLC members still elect S-corporation tax treatment for their companies. Along the same lines, C-corporations may ultimately benefit from S-corporation status. However, there are numerous restrictions corporations must abide by; for instance, shareholders must be U.S. citizens or residents, and there is a 100-shareholder limit.
For a thorough work-up of your company’s tax and legal structures, contact our firm to set up a consultation today. Attorney Tyler Q. Dahl is also a Certified Tax Coach, a designation shared by fewer than 100 attorneys nationwide. Call us at (916) 545-2790 to discuss your options.
Dahl Law Group
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