Somewhere along your entrepreneurial journey you may have asked yourself the question: does becoming an S Corp make sense for my creative business? Oftentimes, electing to become an S Corp is sold as a clever way to save on taxes and who doesn’t want to save on taxes? This aspect alone can make being an S Corp very attractive but before we answer your question, let’s briefly dive into what an S Corp is.
What’s an S Corp?
An S Corporation is a tax election you can make for your business after you’ve established an LLC or Corporation. If you’re currently operating as a sole proprietorship, you first have to set up a new entity before you’re allowed to make the election.
When you tell the IRS you’d like to be an S Corp, you’re deciding to pass all your business profits through to yourself as the owner (the shareholder) of the corporation. Then, you’ll report the flow-through of that income on your personal tax return. This allows your business to avoid double taxation on its profits since it’s only taxed at your individual income tax rate.
S Corps can also be used as a strategy to reduce the amount of self-employment taxes an owner is liable to pay. Typically you pay self-employment taxes on 100% of the income received through the business but with an S corporation, you only pay tax on the W2 wages you receive as an employee of your business (more on that in a minute). Any other earnings above and beyond your salary are not subject to self-employment taxes.
Things to consider when forming an S Corp
While all of those tax benefits sound amazing, It’s important to keep in mind the S Corp election comes with new compliance requirements and it can therefore add more complexity to the handling of your business finances.
New S corp compliance requirements
1. A separate business tax return has to be filed and this means additional tax prep fees. Your bookkeeping should also be on point; this is so you’re able to provide a full set of financials (profit and loss, balance sheet etc) to your accountant.
2. As an owner, you’re required to take a reasonable salary through payroll for the services you provide your business before you can receive any other type of distribution. The IRS likes to make sure S Corps aren’t disguising salaries as distributions to avoid paying payroll taxes. You’ll need to sign up for a payroll service so they can handle withholding taxes, filing tax forms, and submitting a W2.
3. An accountable plan, which is a reimbursement policy, needs to be implemented. This allows you to get a business deduction for expenses which may have been paid personally or for those that are a mix of both business and personal e.g. home office and auto expenses. It’s important to reimburse yourself through the accountable plan, otherwise that money could be viewed as taxable income by the IRS.
As we said, it does make things more complex and because of those added compliance costs, it only makes sense to pursue an S Corp if your business has enough sustainable profit to outweigh the new expenses.
Is an S Corp right for my business?
Deciding to elect S Corp status may not be as black and white as the advice on social media alludes to, but it does have its benefits for certain creative businesses.
There are just lots of factors to be considered to ensure you’re making the right choice.
If you’d like to get a personalized answer to this question, with your business goals in mind, Revel is here to help. We offer advisory meetings with our monthly clients as well as consultations when you’re in need of an expert brain to pick.
Ready to get started? You can reach out to us here.