Living the self-employed life has many perks: you can choose your office hours; create your own goals and systems. But self-employment does have a significant downside: you have to pay self-employment tax (*inserts gasps).
The reactions I receive from business owners, freelancers, and consultants when they realize their income is literally swallowed up by self-employment tax has run the gamut of nervous laughter to deep sobbing. Depending on your setup, you may be able to reduce self-employment taxes by forming an S-corporation.
What Is the Self-Employment Tax?
When a business employs you; the employer must pay half of your Social Security and Medicare taxes. The remaining half of taxes is taken out of your paycheck. However, if you are self-employed, you are responsible for both in its entirety.
How S-Corporations Are Taxed
Many small to medium sized businesses choose to be taxed as S corporations so they company’s income on their personal tax returns which is one of the biggest attraction to business owners. I mean who doesn’t love tax advantages?
The breakdown on S-Corporation Distributions
Let’s take a closer look into S-Corps. If you decide to establish your business as an S-corporation, you can classify a portion of your income as salary and the other as a distribution. It is important to note that you will still be responsible for self-employment taxes on the salary portion of your income. Now before you start jumping for joy; you still must pay ordinary income tax on the distribution portion.
Elect to Be Taxed as an S-Corporation
You can form a corporation by filing the applicable paperwork with the secretary of state or other designated agency in the state where your business is located. If you do nothing further, the IRS will automatically tax your business as a C-corporation that pays corporate income tax.
Self-employment taxes can be a huge financial burden for business owners. You can’t avoid them, but forming a corporation and taking advantage of S-corporation taxation could possibly save you a couple thousand dollars each year.
Keep in mind laws differ from state-to-state. I suggest doing some research into the pros and cons of becoming an S-Corporation to help you in the decision-making process and seek tax counsel to determine the best choice that meets your needs.
If you’ve recently began the process of forming a corporation or have questions about your individual or business taxes, contact our office today for a consultation at 216-202-4194 or email@example.com.
*About the Author: Robin Boyd, President / CEO of Essential Accounting Consultants / Entertainment Accountant Specialist. She connects with Entrepreneurs, Home-based business owners and Entertainers across the country to help them plan and prepare their income tax returns.