If your sole proprietorship business brings you about $100,000, you may want to read this article as you may be able to save $4,000 self-employment tax annually!
Sole Proprietorships
As you may know Sole proprietorship is not a separate legal entity. The business owner personally owns all business assets, and at the same time also liable for all the business’ debits. Also, the sole proprietor does not file separate tax returns. All business income and losses are reported on individual tax returns. A sole proprietor is considered self-employed, but not an employee of the business, so he does not receive payroll from the business. Therefore, a sole proprietor has to pay self-employment tax on the net business income. Self-employment taxes include a 12.4% social security tax and 2.9% Medicare tax.
S Corporations
By contrast, S corporation is a legal entity. An S Corporation begins as a C Corporation, and the business can elect S corporation status by filing form 2553 with the IRS. Since the S corporation provides its shareholders with limited liability, the shareholders generally are not personally liable for the S corporation’s debts. An S Corporation files its own tax returns and all its profits and losses are passed through to shareholders’ personal tax returns. The shareholders work in the business are not considered self-employed, but are employees of the S corporation, so the net income is not subject to self-employment tax. However, they must be paid reasonable wages for their services provided to the S corporation. The salary is subject to the regular social security and Medicare tax.
You may also need to aware that there are some restrictions on forming an S corporation, such as shareholders number limitation, residency and type of shareholders’ requirement. Also, some states require S corporations to pay minimum annual state taxes.
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