📊 Business Financial Inputs
Client-Side PrivateRevenue minus ordinary expenses
Includes payroll software (Gusto/ADP ~$600/yr) + CPA corporate Form 1120-S filing (~$1,200/yr).
Estimated Annual Tax Savings (After Overhead):
Equivalent to keeping an extra $615/mo in your pocket.
⚖️ Structure Comparison
All net profit subject to 15.3% SE tax.
Zero payroll required.
Higher tax liability at $60k+.
FICA applies only to W-2 salary.
Distributions are FICA-free.
Substantial tax savings at scale.
How the S-Corp Tax Shield Works
Understanding Self-Employment Tax vs W-2 FICA under Internal Revenue Code Subchapter S.
Sole proprietors and default LLC owners pay Self-Employment (SE) tax on 92.35% of their net business earnings. This consists of 12.4% Social Security (capped at federal wage limits) and 2.9% Medicare (uncapped).
When electing S-Corp status under IRS Form 2553, you become both an employee and a shareholder. You pay yourself a W-2 salary (subject to FICA), and take the remaining profits as shareholder distributions (completely free of FICA!).
Running an S-Corp requires running monthly payroll (e.g. Gusto, ADP) and filing an annual corporate tax return (IRS Form 1120-S). As long as your FICA savings exceed these overhead expenses, an S-Corp election puts thousands in your pocket.
IRS "Reasonable Salary" Guidelines
Why you cannot pay yourself a \$0 salary and how to avoid IRS audit scrutiny.
A common temptation for new S-Corp owners is to pay themselves an artificially low salary (e.g., \$10,000) to maximize FICA-free distributions. The IRS is acutely aware of this maneuver and strictly requires that shareholder-employees receive "Reasonable Compensation" before taking distributions.
Key Factors IRS Auditors Evaluate:
- Training, experience, and hours dedicated to the business.
- What comparable businesses pay non-owner employees for similar work.
- Whether business revenue stems from personal services vs capital assets.
- Compensation policies across the industry.
Best Practices for Defense:
- Use empirical wage reports (e.g., Bureau of Labor Statistics, RCReports).
- Avoid setting arbitrary fixed numbers without justification.
- Document compensation rationale in corporate meeting minutes.
- Never take distributions without running W-2 payroll first.
S-Corp Tax Frequently Asked Questions
At what profit level is an S-Corp election worth it?
Most CPAs recommend electing S-Corporation status once your business generates at least \$50,000 to \$60,000 in net profit. Below this threshold, administrative costs (payroll processing and Form 1120-S corporate tax preparation) typically outweigh self-employment tax savings.
When is the deadline to file IRS Form 2553?
For existing calendar-year businesses, IRS Form 2553 must be filed no later than 2 months and 15 days after the beginning of the tax year (March 15). If you missed the deadline, you may still qualify for late-election relief under IRS Revenue Procedure 2013-30.
Does an S-Corp reduce income tax or only self-employment tax?
An S-Corp election primarily reduces Self-Employment (FICA) tax. Both W-2 wages and shareholder distributions remain subject to regular federal and state ordinary income tax brackets.
Should real estate rental properties be held in an S-Corp?
Generally, no. Rental income is already considered passive income and is not subject to self-employment tax. Holding appreciated real estate in an S-Corp can create complex tax traps when refinancing or transferring property. Always consult a licensed CPA for real estate entity structuring.