Many small business owners start as sole proprietorships or single-member LLCs. While these entities offer simplicity and liability protection, they subject all business net income to self-employment tax (currently 15.3%). As your business net profit grows, transitioning to an S-Corporation can lead to significant self-employment tax savings.
How S-Corp Self-Employment Tax Savings Work
In an S-Corp, you divide your income into two categories: a reasonable salary (subject to FICA payroll taxes) and shareholder distributions (exempt from self-employment taxes). By paying yourself a fair market salary and taking the rest as distributions, you legally reduce FICA tax burdens.
Operational Requirements
Operating an S-Corp requires running payroll, filing a corporate tax return (Form 1120S), and keeping detailed corporate records. The administrative costs of payroll and corporate filing must be weighed against the tax savings to ensure S-Corp status is financially viable.