tax strategy for small businesses
The S Corporation tax status introduces an additional layer of complexity for small businesses. It stands out as one of the most widely discussed tax strategies, and rightfully so. Nevertheless, it remains a source of considerable misunderstanding and proves more challenging to implement in compliance with the tax code than many anticipate.
challenge
The S Corporation status effectively enables business owners to segregate their profits into two distinct categories: earnings derived from the owner’s role as an employee and profits from assets/employees. Earnings from the owner’s role as an employee are disbursed as W-2 income, subject to FICA/Medicare tax, which aligns with self-employment tax. Profits stemming from assets/employees are documented on the business tax return and are not subject to the current 15.3% self-employment tax.
The positive aspect is that even without physical assets or employees, the S Corporation status can still prove advantageous. It’s important to note that assets can encompass processes, digital assets, or brand identity. However, executing this strategy comes with some significant challenges.:
- W-2 Wage Payments:
You must pay yourself through W-2 which requires you to setup a payroll provider. There typically are monthly costs to process this and regular tax payments and reporting most be completed. - Reasonable Compensation:
The IRS states you must pay yourself reasonable compensation first before taking draws from your business. What exactly is reasonable and how do you justify it if audited? If your spouse works in the business you will also need to pay reasonable compensation for them. - Additional Costs:
While you do get to reduce self employment taxes with the strategy it is important to make sure that the benefits exceed the costs. You will need to run a reasonable compensation report annually, run payroll regularly and file an additional tax return for your business. These costs can add up so it’s important to understand how much savings you can achieve before implementing.
solution
We agree that the S Corporation election is one of the best tax strategies available. We are also fully equipped to help you elect this tax status as well as stay in compliance:
- S Corp Evaluation:
We can provide an evaluation of your specific situation and determine the savings potential of electing S Corp for your small business. If it’s determined to be beneficial we can then file the necessary forms to notify the IRS of your business change. - Reasonable Compensation:
We have a software tool that will determine what is reasonable compensation for your specific situation. The report that is generated is defendable in an audit. We recommend re-evaluating compensation annually. - Payroll Processing:
We can help setup payroll processing and ensure that you stay in compliance with remitting and reporting the appropriate tax payments to the state and federal entities.
results
Partner with Abbott CFO Solution to assist you throughout the entire process, guaranteeing that you capitalize on this tax-saving opportunity while remaining fully compliant with tax regulations. Implementing this strategy is one of our preferred approaches.