If you're convinced that the S-Corp Tax Election could save you money on your taxes - or if you've already made the S-Corp election for your private practice - your work isn't done yet. S-Corp's can be a smart tax move but they come with a fair amount of work and some additional expenses you'll have to incur. Today, we're talking about the 8 things everything therapist needs to know about the S-Corps tax election.
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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. Remember that 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
If you read my first blog post on how an S-Corp works, you know that 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.
But the setting of 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 probably 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 approach before hiring them.
- 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, so be sure and retain a professional if you feel it would help you.
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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 having employees on payroll - and that includes 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.
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's or Corporation.
Specifically, you'll need to prepare and file the IRS Form 1120-S. Yes, this is something your 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. In many cases, you don't absolutely need to file the Balance Sheet, it is a good best practice that can be extremely helpful as your business grows - and in some cases it is a requirement.
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 SEP-IRA Contributions
This is a really important point that I rarely see discussed. 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.
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!
One last note - your allowed SEP-IRA contributions will ALSO be reduced the the S-Corp tax election. Technically your allowed contributions for any retirement plan will be reduced, but the SEP-IRA is more impacted than some other choices, such as the Solo (or Individual) 401(k).
Neither of these changes is a deal-breaker, but it is something you need to plan for. 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 the last, we've covered the main ways the S-Corp tax election will change your tax exposure. But there are some small nuances you should also be prepared for.
One more common nuance that can trip people up is how their state government treats S-Corps. Most states treat S-Corp the same way the IRS does, but that isn't always the case. California, for example, assesses a tax on the S-Corp itself. 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.
If this feels like a lot to figure out on your own, this might be a good time to work with a tax professional.
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 work out.
There are some professionals who think you can make the S-Corp tax election work at lower income levels, 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.
That's a Wrap 🎬
That's it for this week's post. I know we covered a lot and yet it is but one small part of navigating the entirety of your financial life.
But don't fret - that's where my free Finance Quick Start Guide for Therapists comes in. Click here to claim your free copy!
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. There are a three different ways to work with me, all of which I describe on my services page. One is sure to meet your needs and fit your budget!
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.