Should I Switch to an S-Corp for My Business?
One of our goals this year is to share more educational, planning-focused insights to help business owners make informed decisions, especially those that can significantly impact their taxes and cash flow. Think of this as guidance you can use before making a move, not after the paperwork is already filed.
With that in mind, let’s talk about one of the most common questions we hear from solo small business owners:
“Should I switch to an S-Corp to save on taxes?”
If I had to rank the most frequent questions we get from solo small business owners, the #1 spot would definitely belong to: “Should I switch to an S-Corp to save on taxes for my business?”
Is it the right play for you? Maybe, maybe not.
Influencers love to talk about this because it gets them more views and more likes. Tax professionals love to talk about S-Corps because they can charge a lot more money for an S-Corp tax return.
The big selling point is that you can save on self-employment taxes (essentially the Social Security & Medicare taxes). This is 100% true and can be a significant benefit.
The thing is: nobody ever wants to talk about the downsides of being an S-Corp. The downsides don’t get more Instagram views, and the downsides don’t make tax professionals more money when we send you our tax preparation invoice.
Why an S-Corp Isn’t Always the Right Fit
Here are a few big reasons you may want to reconsider switching to an S-Corp:
Payroll headaches & complexity
Now you’ll be paying yourself a W2 wage on payroll, which means you have to get set up with a payroll company. You’ll have to pay yourself a salary (and make sure you have the money in the bank to pay yourself, even in slow months). You’ll have to get set up with all of your state & local payroll taxes. By the way, this stuff isn’t free.
Increased tax return costs/fees
Instead of just including your business with your personal return on Schedule C, you (or your tax professional) will have to file a corporate return as well. These are much more complex and require a lot more work, which means your tax preparation cost will go up significantly. If you save $1,000 on taxes by switching to an S-Corp, and you pay an extra $2,000 to get your taxes done, did you really make the right move?
What’s a “reasonable salary” anyway?
The big kicker of an S-Corp is that you must pay yourself a “reasonable salary” that’s subject to self-employment taxes. Unfortunately, the IRS doesn’t give you much guidance on what a reasonable salary should be.
The best explanation I’ve seen is:
“How much would you have to pay someone to replace you and do your exact job today?” Is your salary reasonable? Would the IRS agree in an audit situation?
Should you do it?
There’s never a generic answer when it comes to your taxes. Rules of thumb tend to forget your other 8 fingers. The best way to arrive at your answer is to work with a professional you can trust.
Have your tax professional run an analysis to show you any potential tax savings you’d get by switching to an S-Corp. Ask your tax professional how much they’ll charge to prepare your potential S-Corp return. Get quotes on prices from payroll providers.
If you’d like to walk through this scenario with a tax professional that has your best interest in mind, schedule your no-cost introduction call here: https://calendly.com/tomorrowlandtax/intro.