Whether you're thinking about the S-Corp... already have one... or just want to know what the fuss is all about... this is the blog post for you!
We're going to cover eight of the essential facts you need to know to manage an S-Corp successfully.
But really, that's just the tip of the iceberg. (And it's the perfect place to get started!)
If you're looking for a deeper dive — and really want an in-depth and clear explanation of how this S-Corp things works — check out my (free) 40 minute webinar. It's available immediately and one practice coach called it the clearest explanation of the S-Corp she'd ever heard!
Watch the video 🎥 here 👆
~ or ~
Read the post 📚 below 👇
Yes, an S-Corp can save you money on taxes. But there are a number of additional administrative burdens maintaining and S-Corp will place on you. And there are a number of non-tax expenses that will increase as a result of you having made the S-Corp Election.
Be sure and make it to the end of this post where I'll share how much you need to be earning in your business before the S-Corp tax election will provide a meaningful tax savings.
1. Make sure you have the right business entity.
To take advantage of the S-Corp tax election, you will be required to have a formal business entity formed in accordance with the laws of your state. That will usually be either some flavor of an LLC or a Corporation.
In many states, professionals licensed by the state must form specially designated "Professional" entities, such as a Professional LLC or Professional Corporation. Be sure and check with your Secretary of State to determine what regulations apply to you! For example, in California, the only formal business entity available for therapists is a Professional Corporations - LLC's are never allowed. And those professional entities usually come with additional restrictions, including around naming, ownership and allowed business activities.
If you don't already have one, forming such a business entity will require you to incur additional expenses and perform additional administrative work, including potentially have to hold Board of Directors meetings which are documented with formal meeting minutes. Be sure and understand the cost and administrative burden you're placing on yourself before jumping into creation of a business entity!
2. Get Smart on Setting Reasonable Compensation
Setting your salary at a reasonable level (e.g. determining Reasonable Compensation) is THE critical decision you'll need to make which will determine how much money an S-Corp can save you on taxes. This is an area that is confusing - and one where I see a lot of folx get tripped up. (For an expanded discussion of what to watch out for, click here.)
Setting this reasonable compensation needs to be done with care. The IRS may come and check your work and let you know if they agree with the number you come up with. That is never going to be a fun conversation, but it will be a whole lot less painful if you do the upfront work to research and then document your rationale for setting your salary as you did.
There is no one right way to do this, and no way to guarantee that the IRS will agree with your number, but a few ideas to consider include:
- Work with a CPA or other tax professional with expertise in setting reasonable compensation. Not all CPA's are experts in this area, be sure and understand their S-Corp experience and expertise level before hiring them. Check out this podcast where I discuss how to interview and select professional services providers.
- Do some market research. What's "reasonable" often depends on what's happening around you. How much do therapists typically make in your geography? The Bureau of Labor Statistics compiles data you might want to look at.
This can be a tricky area to navigate — I strongly encourage you to get some professional guidance. Not making an informed and balanced decision is one of the biggest mistakes I see folx make.
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3. Accountable Plan for Expenses & Home Office Deduction
The S-Corp election requires that you have an Accountable Plan in place for expenses. What the heck is an accountable plan? It's a plan that governs how your S-Corp reimburses you for business expenses you paid for with your personal accounts. An accountable plan is also necessary for claiming the home office deduction through your S-Corp.
If you don't have an accountable plan in place, the IRS will want to assess FICA tax on expense reimbursements. That means you'd be paying more of the tax the S-Corp election is meant to help you avoid!
Thankfully accountable plans aren't some big, complicated thing you need an army of attorneys to establish. It's really just a simple policy and procedure document - and technically it doesn't even have to be written down (although a written plan is a good best practice). For more information, check out this great post on setting up an Accountable Plan.
4. Run payroll at least quarterly
Part of making the S-Corp election is running payroll for employees — even if that includes only you. Regardless of whether your practice is organized as an LLC or Corporation, once you've made the S-Corp election you MUST run payroll for yourself.
If you already have employee for whom you run payroll, this change won't be that big of a deal. You'll just need to be sure and add yourself to the payroll run.
But if you don't have employees, running payroll will likely be a new administrative process for your business. You don't technically have to hire an outside vendor to run payroll for you, but you'll almost certainly want to. There are so many rules, regulations, filings and withholding requirements you have to comply with, it really is safer (and much easier) to hire an outside expert. Companies like Gusto or ADP will take care of most everything for you. Gusto is particularly popular and isn't all that expensive.
You don't need to run payroll for yourself super frequently, but a best practice it to run your self-payroll at least once very quarter. Navigating the nuance around payroll is another time you might really want to have a good CPA that you can turn to.
Changing the amount of money you earn through payroll from time-to-time is part of being a business owner. Personal financial demands and fluctuations in your practice profits will quite understandably pressure you to change your payroll amount. But use caution here! I've seen many cases where practice owners have made a seemingly innocuous change, which cost them big at tax time. I talk more about this in my free S-Corp webinar, so I'd encourage you to check that out!
5. Corporate Tax Return is Required
Because the S-Corp election is a Corporate tax election, you'll be required to file a corporate tax return. The requirement for a corporate tax return holds true whether you're operating through an LLC or Corporation.
Specifically, you'll need to prepare and file the IRS Form 1120-S. Yes, this is something you could prepare yourself, but you'll likely be better off engaging a professional to make sure it's done properly. There are a lot of nuances to filing out IRS forms like the 1120-S, and frankly your time is likely better spent elsewhere.
And unlike your personal return, the 1120-S is due on March 15th!!
6. More formal bookkeeping requirements
If you're following good bookkeeping practices, your bookkeeping doesn't need to change all that much simply because you make the S-Corp election. There will be additional bookkeeping related to payroll filings, although a good payroll vendor like Gusto will take care of most of that for you.
But you will want to be sure and complete your bookkeeping reconciliations and maintain records that allow you to produce both a Balance Sheet and an Income Statement. That 1120-S tax filing we just covered does require a balance sheet!
Reporting your practice earnings on Schedule C (which is what you do as a sole prop or non-S-Corp LLC) is a bit easier and less rigid than the 1120-S, so once you make the S-Corp election, you do want to make sure your bookkeeping processes are in tip-top shape.
7. Reduced Social Security Benefits + Allowed Retirement Contributions
This is a really important point that I often see missed. The reduction of your Social Security Benefits that the S-Corp election brings about isn't a deal-breaker, but it is something I want you to be aware of and prepared for.
The S-Corp election reduces the amount of FICA taxes you owe. That's the only tax savings it provides. And FICA taxes fund both Medicare and Social Security. Your Medicare benefits are less likely to be affected by reducing your FICA taxes paid, but your Social Security benefits almost certainly will be reduced. FICA is only assessed on your Earned Income - that's the amount of your Reasonable Compensation paid through payroll. And it's that payroll amount that gets included in your Social Security record. And those earnings ultimately determine the amount of your Social Security retirement benefits. (Wow, there are a lot of confusing terms in this paragraph... if you'd like a complete and clear explanation of all of them, click here.)
You may or may not be counting on receiving Social Security Benefits once you reach retirement age. I can't predict the future, but I'm betting that once we all reach retirement age, Social Security retirement benefits will still be around in some shape or form. And if you've benefited from the FICA-tax-reducing benefits of an S-Corp, your retirement benefit will be lower than it otherwise would have been.
This isn't necessary a bad thing. You can take your tax savings and invest them, almost certainly ending up with much more money than you would have received from Social Security. But that requires that you are saving and investing some of your tax savings to better prepare yourself for your golden years when work should be optional!
How can you possibly know how to balance the tax savings of the S-Corp versus future Social Security benefits? And how much of your FICA tax savings should you invest to offset lower Social Security benefits? You're in luck! I've created a worksheet to help you calculate just that.
One additional note - the S-Corp tax election will also reduce your allowed retirement plan contributions. The extent of that reduction will depend on the particular flavor of retirement plan you're using. The SEP-IRA contributions are most impacted, 401(k) contributions and IRA's less so.
None of these changes is a necessarily make the S-Corp election a bad choice. But they are items you need to carefully think through and plan for — ideally before you make the S-Corp election. A good financial planner or tax professional can help you elegantly navigate these issues!
8. Understand your State + Local Tax Nuances!
In this post and most discussions of the S-Corp tax election, we focus on Federal taxes. But there often are additional state and local tax nuances you will want to prepare for.
One more common nuance that can trip people up is how their state government treats S-Corps. Most states don't assess additional taxes on the S-Corp, but that isn't always the case. California, for example, assesses a special annual tax each year. It's not a huge tax but it's one of those small nuances you need to be aware of when analyzing whether the S-Corp is a smart tax move for you. Live in New York City or Tennessee? Taxes there almost certainly make the S-Corp a poor financial choice. Again, careful evaluation and planning is crucial. In New York, if you move from Brooklyn to Bayshore, all of the sudden the S-Corp might become massively attractive.
If I haven't made it clear yet, when making the S-Corp election, it is essential to be working with a good tax professional.
And while I love my tax-focused colleagues, they aren't always the best at explaining how things work in a clear, understandable way. My free S-Corp webinar can give you the vocabulary and knowledge you need to make communicating with your tax professional SO much easier.
Is this S-Corp Election right for you? 🤔
This is a hard question to answer because there is so much nuance around how your business runs and the state and local taxes you might incur, so the right decision here is always going to come down to personal choice!
The general rule of thumb is that your business should be generating more than $60k annually in profit before the S-Corp is likely to be beneficial.
You will incur around $3,000 in additional annual expenses, although that number might be a bit lower depending on the external vendors you choose to work with. Not until you're making more than $60,000 annually with this likely work out.
Between $60,000 and $100,000 of annual earnings is when I believe the S-Corp may or may not save you money— sorta a gray area. Once you're consistently making above $100,000 the S-Corp election will almost certainly save you money. But it's still a personal decision — establishing and then managing an S-Corp is no small task. Consider whether you're ready — or want to — take this all on. Just because something will save you some money means it's the absolute right thing for you to do immediately. If you want more support thinking this through, my free webinar is a great place to begin.
There are some professionals who think you can make the S-Corp tax election work at income levels lower than $60,000, and they might be right depending on where you live and what your state and local tax picture looks like. But to really see the benefits, I like to see people making more than $60k. That will make it much more likely that you will experience meaningful FICA tax savings and that those savings will more than cover the incremental expenses the S-Corp election will introduce into your business.
Conclusion & Next Steps 🎬
WHEW! This S-Corp stuff is a LOT.
If I haven't made it clear by now, the S-Corp election isn't a decision you should make lightly. Treat it like a marriage — sure, you can un-do the election, but it isn't easy and can be a bit painful to get out of. Especially for newer practice owners, I see more folx who regret having made the S-Corp election too soon. "I wish I had done this sooner!" is NOT something most practice owners say about the S-Corp.
If the S-Corp is something you're seriously considering, I would really encourage you to do your research. At the risk of sounding immodest, I do believe my free S-Corp webinar is a great place to round out the education you're begun here today.
And if this all feels a bit much to navigate on your own, give me a shout! I work one-on-one with therapists from all over the country. Click here to learn more about how I work.
Turning Point is a registered investment advisor in the state of California. Please visit turningpointhq.com for important information and additional disclosures. This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes financial, legal or tax advice; a recommendation for purchase or sale of any security; or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Read the full Disclaimer here.