July 8th 2024.
Did you know that there are five million small businesses operating as S corporations? These businesses have discovered a little trick that can save them a lot of money. By paying themselves a low salary, they can avoid paying payroll taxes.
Unfortunately, many S corporation owners are unaware of the other, more advanced tax planning techniques that can benefit them. That's why in this month's blog post, we're going to delve into these strategies and help you make the most out of your S corporation.
First, let's review the basic S corporation trick for saving taxes. Imagine a business owner earns $100,000 in profit. If they operate as a sole proprietorship or partnership, they would have to pay Social Security and Medicare taxes on most of that amount, which could add up to around $14,000. However, if they operate as an S corporation, they can split that $100,000 into wages and a shareholder distribution, effectively cutting their payroll taxes in half.
While this is a great start, too many S corporation owners stop here and miss out on other powerful tax planning tactics. So let's explore some of these advanced techniques.
Trick #1: Optimize for the Section 199A Deduction with Higher Wages
One strategy is to pay yourself higher wages to support a full Section 199A deduction. This deduction allows you to avoid paying income taxes on the last 20% of your taxable income. However, if your income exceeds a certain threshold, the deduction is limited to 50% of your W-2 wages. By increasing your wages, you can potentially save thousands of dollars in income taxes.
Trick #2: Split a Specified Service Trade or Business to Requalify for Section 199A
If your business includes both specified service trades or businesses (SSTBs) and non-SSTBs, you may lose out on the Section 199A deduction. However, by separating these activities into different S corporations, you may be able to requalify for the deduction and save thousands of dollars in taxes.
Trick #3: Elect to Pay Pass-through-entity Tax
If you live in a state with income taxes, you can save on taxes by having your S corporation pay these taxes directly. This can result in a federal tax deduction, saving you thousands of dollars.
Trick #4: Use Tax-free Fringe Benefits
By loading up on tax-free fringe benefits, you can increase your shareholder-employee compensation without increasing your payroll taxes. For example, providing yourself with health insurance can bump your W-2 wages to a more reasonable level.
Trick #5: Set up a Generous Pension for Shareholder-employees
Pensions are not only a great way to attract and retain talented employees, but they can also be used as a tax planning tool. By contributing to a Simplified Employee Pension (SEP) plan or a 401(k), you can save on payroll taxes and increase your reasonable compensation.
In conclusion, while the basic S corporation trick for saving taxes is well-known, there are many other advanced techniques that can benefit business owners. By utilizing these strategies, you can potentially save thousands of dollars in taxes and build wealth outside of your business. So don't stop at just the basic trick, explore these other options and see how they can work for you.
Did you know that there are five million small businesses operating as S corporations? It's true, and most of these savvy business owners know the simple trick for saving money with an S corporation. The trick is to pay yourself a low salary and avoid paying payroll taxes. It's a small but effective way to save some cash.
Unfortunately, not all S corporation owners are aware of the more advanced tax planning strategies available to them. That's why this month's blog post is dedicated to sharing some of these tricks and tactics.
Let's start with the basic S corporation trick: avoiding payroll taxes. Just to make sure we're all on the same page, let's review how it works. Say a business owner earns $100,000 in profit. If they operate as a sole proprietorship or partnership, they'll have to pay Social Security and Medicare taxes on most of that income, which amounts to about $14,000. But if they set up their business as an S corporation, they can divide that $100,000 into wages and a shareholder distributive share, and only pay payroll taxes on the wages. This can save them over $7,000 a year.
But don't stop there! There are even more powerful and advanced tax planning tactics for S corporations. Let's take a look at some of them.
Trick #1: Optimize for Section 199A Deduction with Higher Wages
One powerful technique is to pay yourself higher wages. You might be thinking, "But why would I want to do that if it means paying more in taxes?" Well, if your business generates qualified business income and you have a high income, you'll need to have enough wages to support a full Section 199A deduction. This deduction allows you to avoid paying taxes on the last twenty percent of your taxable income. However, if your income exceeds a certain threshold, which is around $200,000 for single filers and $400,000 for married filers, the deduction is limited to 50% of your wages. So, if you're not paying yourself enough in wages, you could be missing out on a significant tax deduction. By bumping up your wages, you can potentially save thousands of dollars in taxes.
Trick #2: Split a Specified Service Trade or Business to Requalify for Section 199A
Another trick involves splitting your business into separate entities. If you have an S corporation that operates both a specified service trade or business (SSTB) and a non-SSTB, the entire business may be disqualified from the Section 199A deduction. However, if you split the two activities into separate entities, you can potentially requalify for the deduction. For example, a physician who operates a clinic as well as a continuing medical education service could split these activities into two separate S corporations and potentially save thousands of dollars in taxes.
Trick #3: Elect to Pay Pass-through-entity Tax
If you live in a state with income taxes, you may be able to pay those taxes directly from your S corporation. This can be done by making an election to pay a pass-through entity tax. The benefit of doing this is that you can potentially deduct these state income taxes on your federal tax return, saving you even more money.
Trick #4: Use Tax-free Fringe Benefits
Another way to increase your shareholder-employee compensation without raising your payroll taxes is to take advantage of tax-free fringe benefits. For example, providing yourself with health insurance can increase your compensation without increasing your payroll taxes. This can be a great way to bump up your reasonable salary without incurring additional taxes.
Trick #5: Set up a Generous Pension for Shareholder-employees
Lastly, entrepreneurs should consider setting up a pension plan for their employees as a tax planning strategy. Not only can this be a valuable employee benefit, but it can also help you save on taxes and build wealth outside of your business. For example, a Simplified Employee Pension (SEP) plan allows you to contribute up to 25% of your W-2 wages towards retirement savings. This can not only save you on payroll taxes but also increase your reasonable compensation. There are also options for higher contribution limits with 401 plans.
In conclusion, there are many more advanced tax planning tactics available for S corporations beyond just avoiding payroll taxes. By implementing these strategies, business owners can potentially save thousands of dollars in taxes and build wealth outside of their business. So, don't stop at the basic trick – explore these more advanced techniques and see how they can benefit your business.
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