Just how low can that salary go - that’s the big question for everyone doing an S-Corp.So in this video, I’m going to show you some specific scenarios and examples, that help you understand the types of tax savings you might experience by becoming an S-Corp at various income levels.https://youtu.be/tYghSyLtlz0These examples are fictitious and do not give you the entire story - it’s every business owner's job to consult the 74,608 page tax code - or just hire an accountant to help you do it.This is not legal advice, nor are we responsible for any repercussions there may be from you implementing this without professional and qualified help. We’re going to show you strategies and tactics that can make a ton of sense, but you need to make your own decisions according to the tax code…That being said - let’s kick this off.Two Other S-Corp Videos:Hopefully you’ve watched our video called “The Tax difference between an S-Corp and an LLC", which is meant to cover lots of the basics of S-Corps and LLCs. If you haven't, be sure to click the button below to view this one first.See our other S-Corp video which explains the tax differencesNot only should you have watched that video - but then you MUST watch our other video walking you through the 3 major drawbacks of an S-Corp. An S-Corp is an amazing tool, but you definitely need to be aware of the drawbacks and potential problems - so check that video out as well.Alright - now to show you how much you could expect to save if you convert to an S-Corp, particularly from an LLC taxed as a sole proprietor.
When you become an S-Corp, the main idea is that the corporation will be paying you a reasonable salary and then you’ll also have an owner's distribution or a dividend or draw.The income is split into two parts, the salary (or payroll amount), and then the owner's distribution.The salary IS subject to self-employment taxes, while the distribution is not.That means that the distribution is highly tax efficient - because it’s not subject to the 15.3% self-employment tax. Self-employment, if you remember, is a combination of Medicare taxes and Social Security taxes.The payroll (salary) is taxed at a full 15.3% up to the social security limit - which for 2017 is going to be moving up more than 7%, increasing $8,700 - to a threshold of $127,200 - from $118,500 in 2016.This means that all your income on the salary or payroll side - up to that Social Security $127,200 limit - will be subject to the 12.4% Social Security and the Medicare tax of 2.9% - Which equals 15.3%Besides that 2.9% Medicare tax, there can be an additional Medicare tax when your income is above a certain level. This is relevant for married people earning $250k and filing jointly, or making $125k and filing separately, or single filers earning 200k.Since only the salary or payroll is subject to self-employment taxes, the goal would be to take only as much salary as is legally required - but nothing more. The lower you keep the salary, the more you save in self-employment taxes.
That is the great dilemma for business owners - how low of a salary can you take.On one hand, you’ll hear advice telling you that you should be paying yourself what you’d make at another job doing this… Except for that whole problem that you’re a SMALL BUSINESS and the net profits might be totally different than someone else doing the same job for a larger corporation.Then you have others that say you should be deciding salary amount based on a percent of your net profit - adjusting the salary as your business fluctuates.And then you have others that use more complicated methods.Here's what I’ve observed.The IRS has had plenty of cases to set precedent - and you want to make sure that you’re making an informed decision… There is no absolute correct answer here - except that the salary should be “reasonable” and that your accountant can help you make an informed decision in order to mitigate the risk of being audited and having your salary get reclassified.Imagine you go through a couple of years of being too aggressive, and then suddenly have multiple years worth of distributions get reclassified as wages, and you’re forced to pay 15.3% SE tax on those and then penalties and interest! That can be an UGLY wake up call for most people.Talk to an accountant, make sure you have great bookkeeping, a tax plan, and wise accountants giving you advice - I highly recommend NuanceFinancial.com for this.What an accountant is likely to do is teach you that there are a number of TENSIONS to manage when deciding a salary - not a hard and fast rule.The first tension is your net profits - if you don’t make money, why would you pay yourself large salaries? That doesn’t seem like it would make sense.Next would be your industry norms and previous salaries. You should probably consider your industry when it comes to how low of a salary you dare take.Then you have to measure your risk - if you have LOTS to lose, and you’re taking lots of aggressive tax planning tips - you want to be sound in how you make this decision.In just a bit I’ll share what I’ve heard many tax planners advise their clients on- how low of a salary can you take in an S-Corp…But really quick, I want to show you how much you might save in self-employment taxes if you were to do a 50/50 split at different levels of income.
I’m going to show things here that aren’t complicated math - so I don’t mean to offend anyone or act like you’re stupid and insult your intelligence.SO….IF you had net profits of $30,000 - and you chose to do 50% salary and 50% dividend, you would save about $2,300 in self-employment taxes.At $75,000 in net profits - with a salary of 37,500 - you’d save about $5,737 in self-employment.At $75k - you’re making $6,250 a month - and you’d go from paying $11,475 in self-employment taxes or $956 a month - to paying about $478 a month.Finally, at $110,000, you would save about $8,400 in SE taxes.Then at that $110,000 - you’re earning $9,166 a month - and you’d go from paying about $16,830 in SE at $1,402 a month - to paying only $8,400 in taxes at $700 a month.Now that’s the actual savings you’d see - but that doesn’t really tell the whole story because you need to consider opportunity costs of that money. Remember, opportunity costs tell the story of the money you could have made if you would have had that money to invest in various ways.Let’s look at the opportunity costs if you would have invested those savings into the stock market.If you invested these amounts in an S&P 500 index fund at Vanguard - earning about 8% a year for the next 25 years - this money really adds up.Take a look at this - 8%, invested monthly, over 25 years.The savings from 30k in net profits, you would have saved a total of $114,600 - and have an investment account with $173,617.At 75k - over 25 years you would have saved a total of $143,400 in self-employment taxes - and you could have an investment account of $452,882 after 25 years.At the $110,000 net profits - you would have saved a total of $210,000 in taxes - and if you invested that $700 a month, earning 8% annually, you would have turned that $210,00 savings into a $663,217 investment portfolio.So it can really pay to do this S-Corp thing! Those scenarios are using about 50% of the net profits as salary - is that even the lowest you could go?Tax advisors are all over the place on how low they think you can go with your S-Corp payroll as a percent of net profits - this example was 50% - but some might tell you they think it should be a dollar amount and some would tell you a percentage even higher or lower…Here’s a what I’ve personally heard major CPAs say - very public and famous CPA’s - about what percentage you should use as a salary…. I’ve heard them teaching their clients to be really aggressive on their S-Corps - within reason and weighing the risk - to never take less than 1/3rd of their net profits as a salary.That’s right - there are CPA’s all over the place that would look you right in the face and tell you that you should shoot for taking ⅓ of your net profit as a salary - and the rest as a distribution!This isn’t my legal tax advice - but I’m telling you - this is the type of thing thousands of business owners are doing… I’ve even heard some go as low as 25% - but I think that’s just too low.But let’s play with that 1/3rd number again -Now - if you were to do 1/3rd as a salary - and invest for 25 years, earning 8% - here’s what you might see.At $30,000 in net profits - you’d see savings of about $3,060 a year or $255 a month.After 25 years - you’d save $176,500 and have a portfolio of $241,600.At $75,000 in net profits - savings of about $7,649 a year or $637 a month -After 25 years - you’d have saved $191,100 in self-employment taxes and have a total portfolio of $603,527At $110,000 in net profits - you’d see savings of about $11,200 a year, or $935 a month.After 25 years - you would have saved $280,500 in self-employment taxes and have a total portfolio of $885,868!Obviously things vary for every company - and I’d love to hear CPAs and professionals give their two cents about what they recommend down in the comments section - sound advice from this community is helpful!And obviously investments can vary…But folks - you can save massive amounts of money in an S-Corp... Just remember there are drawbacks that you need to know about - and you should definitely watch our video about the 3 drawbacks of an S-Corp below.Thanks for reading and for watching our small business videos. If you're looking for more entrepreneur and small business advice, check out the Feedbackwrench Youtube channel for the best small business youtube channel.