S Corp Tax Calculator and Estimated Tax Savings

S corporations are known for their tax savings, particularly their avoidance of double taxation and the ability to reduce the amount you pay for Social Security and Medicare (self-employment tax). To determine whether an S corporation is right for your business, let’s start with explaining what an S corporation is and then walk through how may save you money.

S corporations are particularly tax advantageous in that the company can legally avoid double taxation and save owners money on self-employment taxes. Double taxation is when tax is paid twice on the same income. C corporations are subject to double taxation. The company’s income is taxed at the corporate level and then, when profits are distributed to the shareholders, the distributions are taxed again on the shareholders’ personal income tax returns.

An S corporation is not a separate type of business structure but rather a tax election made under Chapter S of the Internal Revenue Code. S corporations have the liability protection of a corporation, but the S corp, itself, is generally not subject to regular federal income tax. Instead, like an LLC, most income and expenses of an S corporation are passed through to the shareholders. Not sure what an S corp is? We define S corps to help make it easier to understand.

Tax Treatment of S Corps vs LLCs

LLCs and S corporations both benefit from pass-through taxation. This means that the business’s income passes through to the owners and they only pay income tax once at the individual level.

In addition to income taxes, LLC members and S corporation shareholders who work in the business also must pay Social Security and Medicare taxes.  LLC members pay this amount in the form of self-employment tax, calculating it the way a sole proprietor does. S Corporation shareholders who work in the business are considered salaried employees by the IRS, however.  As employees, they pay their Social Security and Medicare taxes (called FICA) through payroll taxes that are deducted from their salary

In an LLC, all of the income passes through to the owners. Thus, they pay self-employment tax on all of the income.

Although S corporation owners who perform services in the business must pay themselves a salary, they don’t have to take all the profits out of the company in the form of salary. They can choose to receive some income from the business as a profit distribution instead of salary.  Such distributions are not subject to self-employment tax. (See additional details below)

While it might be tempting to pay the bulk of one’s earnings from the business as a distribution to avoid the self-employment tax, it’s important to note that the IRS requires shareholders’ salaries to be “reasonable.”

Self-Employment Taxes vs Payroll Taxes

Anyone who earns money from working is required to pay Social Security and Medicare taxes. For Sole Proprietors and LLC owners, this tax is called self-employment tax (SECA). For employees, it’s called FICA. Your employment status determines the percentage you will pay. If you are an employee, you pay 7.65% and your employer pays the other 7.65%. Those who are self-employed pay the entire 15.3%.

Herein lies the power of the S corporation. Owners of S corporations can reduce the total Social Security and Medicare tax by taking some of their profits as shareholder distributions instead of salary. As we explain below, you may be able to reduce your tax bills by creating an S corporation for your business.

For example, if your one-person S corporation makes $200,000 in profit and a reasonable salary is $80,000, you will pay $12,240 (15.3% of $80,000) in FICA taxes. The remaining $120,000 is not subject to self-employment tax but rather passes through to the owner as a distribution of profits.  On the other hand, if you have a one-member LLC that does not elect S corporation tax status, the entire $200,000 profit is subject to self-employment tax (SECA). Thus, you will owe $30,600 (15.3% of $200,000) in self-employment taxes. By comparison, you’d save $18,360 less in self-employment taxes.

Note: This example does not take into account the fact that corporations can deduct salary and payroll taxes as a business expense, and the self-employed can deduct one-half of their self-employment tax.

Salaries and Distributions

S corporation profits may be divided into two income groups: salaries and distributions. 

Salaries

Salaries paid to S corporation shareholders/employees must be “reasonable.” The IRS does not provide any guidance on what is “reasonable,” but you should consider the following factors:

• The employee’s duties and responsibilities;
• The employee’s training and experience;
• The amount of time contributed to the business;
• The amount of dividends paid to shareholders;
• Non-shareholders’ wages; and 
• What similar businesses pay for comparable services. 

The IRS imposes serious consequences for unreasonable salary amounts. IFor example, say an owner decides to pay themselves a lower than reasonable salary to classify profit as a distribution and pay less in taxes. The IRS has the power to step in and reclassify those distributions and levy fines. Penalties may include payroll tax of up to 100% and negligence penalties, which are 20% of the net understatement of tax. 

Distributions

Distributions made to S corporation owners are passed through onto their personal tax return, using a Schedule K-1, which are then taxed as ordinary income.

SECA vs. FICA

SECA (Self-Employed Contributions Act) requires self-employees to pay SECA taxes on their net earnings. SECA funds Social Security and Medicare. Self-employed pay the entire portion but can deduct half of the self-employment tax as a business expense. 

FICA (Federal Insurance Contributions Act) requires employers to withhold taxes from employee earnings to fund Social Security and Medicare programs. These are commonly referred to as FICA taxes. The employer pays half (7.65%), and the employee pays the other half (7.65%) through withholdings in their paycheck. S corporation owners who work in the business are not “self-employed for tax purposes. They are W-2 employees. Thus, they pay into FICA  instead of paying self-employment tax.

In addition to the employer’s share of FICA, S corps, like all employers, must pay federal unemployment insurance (FUTA) and may also have to pay workers compensation and disability insurance.

The amount of payroll tax your S corporation pays depends on the amount of your “reasonable salary.” Paying yourself a low salary and taking a high distribution will bring you the most savings. But remember, your salary must be “reasonable” or else you could face serious consequences.

S-corp Tax Deductions

S corporations are allowed to deduct salary, payroll taxes, and other business expenses from their profits. They report these deductions and their income to the IRS using Form 1120-S.

State Franchise Taxes

State franchise taxes are the cost of doing business in a particular state. These are separate, and in addition to, state income taxes. S corporations are subject to state franchise taxes, but not all states have them. Franchise tax rates vary widely from state to state. S corporations must pay franchise tax to the state where they are incorporated.

Before electing S corporation status for your business, you should be aware of all the taxes your business may be subject to and determine whether electing S status is advantageous. 

How to Form an S corporation

To form an S corporation, create either an LLC or corporation and make an election for “S” status on the IRS Form 2553. The IRS must receive the form within two and a half months of when you file your business formation documents with the appropriate state agency. Otherwise, you have to wait until the following year to get the S corporation tax status. 

Learn more about how to Form an S Corporation.

LLC Formation Requirements

The formation requirements for an LLC are simple, which is why so many small businesses like them. You file Articles of Organization with the agency that governs business formation and compliance in your state along with a state filing fee. There are few ownership restrictions or requirements, and you can run your business more your way. To keep your LLC in good standing, you will likely need to pay an annual or biennial filing fee to the state. 

Corporation Formation Requirements

There are strict legal requirements when forming a corporation, and the corporation’s operations are subject to more stringent rules. While the laws vary based on each state, generally, a corporation must have at least one director, appoint officers, hold an organizational meeting, adopt corporate bylaws, and issue shares. Corporations are prohibited from owning shares in an S corporation but can be the underlying business structure of the S corporation.  

A CPA can walk you through an LLC vs. C corp vs. S corp calculator to help you decide if S corporation status is right for your business.