When Should I Become An S-Corp
Once we gain traction growing our small business, this phrase “S-Corp” keeps popping up everywhere – Tik Tok, our savvy friends, and our business colleagues. It has you questioning “should I become an S-Corp?!”.
But what does an S-Corp really mean and how do I know if it’s right for my business? – OR – I’m already an S-Corp, how do I know if it’s always going to be the right election?
The Truth About S-Corps
Well – my goal here is to break it down in layman’s terms so you can make an informed decision that you actually understand. The ONLY benefit to being an S-Corp is potential tax savings.
As an S-Corp, you get to avoid self-employment taxes (15.3%) on your entire business’s net profit (income minus expenses), and only pay those taxes on what you pay yourself in wages.
So, if your business has $50K net profit, and you only pay yourself $30K in wages – you’re saving $3,060 in taxes, right? – ($50K – 30K)*15.3%. Wrong!
Because being an S-Corp comes with added complexity. Likely, you will have to pay an additional $2,500 (minimum) per year for administrative costs of an S-Corp –an additional tax filing, having to run payroll, and having to keep more formal records.
Ouch – that brings my tax savings down to $560. But wait, if you live in a state like Tennessee, they treat S-Corps like a Corporation and charge an excise tax of 6.5% – so that’s an additional $1,300 of annual taxes. That wipes out your savings completely!
For a more profitable business, the case for the S-Corp could still work well. Let’s say your net profit is more like $100K and you pay yourself $50K in wages. Even in Tennessee, you’re still saving $1,900 annually in taxes by being an S-Corp ($7,650 – $3,250 – $2,500).
Your Takeaway
The biggest takeaway I want you to have is, start thinking about the S-Corporation election when you’re at around $75K – $100K in annual net profit. Before that point, it’s likely a lot more hassle than it’s worth. If you do make the S-Corp election, make sure you understand the complexities of it and requirements to stay compliant. Ask questions!
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About Gradient Accounting
Gradient Accounting is a firm built with modern small businesses in mind. Our mission is to help you get your finances under control so you have time to travel, enjoy your life, and pursue your passions. Our team has more than 33 years of cumulative accounting, tax, and consulting experience. Our blog reflects our unique take on the latest news you need to know in the small business world. We are also passionate about providing free resources here to help you scale your business and earn more money in the process.
I have been going back and forth about this. I love the way that you broke it down . Especially when we are talking numbers. Now I know when I should consider taking this step. Is the S-Corp the same as a sole proprietorship?
Hi Jameela! Thanks for reading. The S-Corp is different than a Sole Proprietorship. See the differences below:
Sole proprietorship – This is the default business entity. There are no formation requirements. Optional: The business owner can get a business license with their city or county.
S-Corp – An S-Corporation must first be an LLC or C-Corporation. Therefore, they must complete the paperwork to form an LLC or Corporation with their secretary of state. From there, they need to file special election paperwork (Form 2553) with the IRS to elect the S-Corporation tax designation.
Since they are registered as a LLC or a Corporation with their state, they must file an annual report with their state and pay a fee which costs anywhere from $25 to $500 per year depending on the state.