By I know you report your business on Schedule C of your Form 1040.
Have you noticed that the self-employment tax significantly drains your cash? The S corporation may plug a good chunk of that leak because only the W-2 wages that the S corporation pays to you would suffer federal employment taxes.
Here’s the big picture: The S corporation
- deducts the W-2 wages;
- passes the remaining taxable income to you—the shareholder who reports the income on his Form 1040; and
- makes cash distributions to you—the shareholder.
The passed-through S corporation taxable income increases the tax basis of your stock; therefore, distributions of corporate cash flow are usually federal-income-tax-free.
This tax regime places S corporations in a potentially more favorable position than equivalent businesses conducted as sole proprietorships, single-member LLCs that are treated as sole proprietorships for federal tax purposes, partnerships, and multi-member LLCs that are treated as partnerships for federal tax purposes.
That’s because S corporations can follow the tax-smart strategy of paying modest salaries to shareholder-employees while distributing most or all of the remaining corporate cash flow to them in the form of federal-employment-tax-free distributions.
If you would like to examine the potential tax savings available to you with a switch to the S corporation, please call me on my direct line at 408-778-9651.