If you’ve been bringing in steady income as a solopreneur for a while, there’s one change you could make that could mean saving major money on your taxes: becoming an S Corp.
Understandably, you want to grasp the ins and outs before making a change to your business—and there are a lot of misconceptions about S Corps out there.
*Kelly is advanced certified in QuickBooks Online
An S Corporation (S Corp) is a tax status you can elect for your small business. That means it changes the way your business is taxed.
You’ll need a business entity (like an LLC) to submit an S Corp election. When you do, you still have an LLC—but your LLC is now taxed as an S Corp.
So why is it helpful to change the way your business is taxed? Put simply, you’re “saving on self-employment tax,” Kelly says.
As a sole proprietor or single-member LLC, all of your business income is subject to self-employment tax (roughly 15.3%). But, as an S Corp, you split your income between:
That means you reduce the amount of income that’s taxed at that full self-employment rate—legally and strategically, of course.
But here’s the important thing to remember: You need to do this right.
Setting a reasonable salary is where Kelly sees most business owners get into trouble. “That’s really what the IRS tends to pay the most attention to,” she advises. So, you don’t want to set an unrealistically low number just to shave more off your tax bill.
“If you were to step out of the business and hire somebody to do this role, what would you pay them?” Kelly asks. “What’s the industry standard for that role?” Those questions will help you determine a reasonable salary that saves you money—without getting you in hot water with the IRS. If you don’t want to do the research and crunch the numbers yourself, Lettuce will automatically calculate your reasonable salary based on several factors.
Wondering how much you could save by making the switch to an S Corp? Quickly run the numbers with Lettuce’s tax savings calculator.
No freelancer or solopreneur wants to overpay their taxes, so the benefits of an S Corp are compelling. With that said, this tax status is a better fit for some solo business owners than others. Here are three surefire signals you’re ready for S Corp status.
“I lean toward $50,000 to $60,000 net profit before moving anybody or suggesting that anybody move to an S Corp status,” Kelly explains.
Especially if you’re reaching (or exceeding) that net profit threshold consistently or you’re projecting that your income will continue to grow, then making the switch to an S Corp could mean serious savings at tax time.
The administrative headaches are one thing that scares solos away from S Corps. And it’s true that there are some extra logistics you need to take care of as an S Corp. “It’s a commitment to running payroll, being consistent, and following the rules,” says Kelly.
“Following the rules” means setting a reasonable salary for yourself, but also:
That doesn’t necessarily mean you need to take all of this on yourself. An automated solution like Lettuce can do all of the hard work for you, so you can get the benefits of an S Corp (without the added burdens).
Electing S Corp status is an undeniably smart tax-savings strategy, but that doesn’t necessarily mean you want to jump right in the moment you start your business.
“You need to be consistent a little bit before you’re ready to take that step,” Kelly explains. “I think there needs to be some time spent in the business and running the business before you move to that status.”
That’s not to say you need to be perfect or have all the answers. But you do want to have some confidence and a strong commitment to running your business successfully now and in the future.
If you’ve been wary of electing S Corp status up to this point, here’s the bottom line: “You’ll save money,” says Kelly.
Were you nodding your head to all of the criteria above? Then, making the switch to an S Corp could be one of the best ways to save serious money on your tax bill.
Think that means more paperwork and problems? Think again. Check out how Lettuce can make your S Corp election quick and painless.