Save Big Tax Money; Go Sub S!

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usiness owners, then you run your business as sole a proprietorship or a C Corporation. If so, you might want to check out becoming a Subchapter S corporation! There are many benefits, but I?m going to discuss one of the best, saving Self Employment (Social Security) taxes.

A sole proprietor must pay self employment taxes on all the income earned from the business. That?s 15.3% on your first $72,600 and 2.9% on all the rest of your income. On $100,000 earnings, that?s almost $12,000 in self employment taxes! I?m sure you?ll agree you can probably get a lot better return on that money if you invested it yourself. That is even assuming you will get any of this money when you retire. By then, the retirement age might be higher, pay out less, or you might be entirely ineligible for SS benefits because of your investment income (there?s been talk of using this as a qualifier to SS eligibility).

Instead, form a corporation and file for Subchapter S status with the IRS using Form 2553. There are, of course, restrictions. However most small businesses are eligible to do this. Let us use me as an example.

One of my first corporations was set up for my insurance business. It started out as a sole proprietorship. Then, my accountant told me about the benefits of a Sub S Corp. So, I formed The Banner Agency, Inc. and immediately filed for Sub S status with the IRS (you must do this by the 16th day of the third month of the forming of your corporation). Then I paid myself a salary (you must do this too). My accountant suggested I pay myself what it would cost to hire someone else to run my business in my place. Since my agency was young, I decided I could only pay myself $12,000 per year the first year. Although I realized this was small, and probably less than what I would hire someone for, I figured I was OK since my business was in its infancy and profits were not very predicable (the next year I paid myself $18,000). If you?ve been operating for a while and/or earning more money, you will want to pay yourself more.

After the first year, I had $12,000 in W2 income and my corporation earned another $25,000, for a total of $37,000. The approximately $2000+ per month in profits, I paid myself as an "owner dividend" each month. Social Security & Medicare taxes (as employer and employee) were due on the $12,000 W2 income. But, I saved the self employment taxes on the $25,000 as this was considered non earned dividend income. In other words, I saved almost $4000 ($25,000 X 15.3%) in taxes! The following year savings were even greater as my earnings were higher. The key here, is that all profits earned by your corporation are taxed as non earned income at your normal federal and state personal tax rates, but NOT by Social Security or Medicare!

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