Need Some Deductions for 2011?

Don't overlook these!

Updated for 2011

Business Structures

<< Previous

How to Reduce Your FICA Taxes if You Own an S-corporation

If you're an S-corporation shareholder and work in the business, you are classified as an employee of the corporation (shareholder/employee) and are treated the same way as any other regular employee is treated for income tax withholding purposes.

If you're a member (owner) of an LLC and an election was made to treat the LLC as an S-corporation for tax purposes, you are classified an employee of the LLC (instead of being considered a self-employed person had no election been made). The LLC would file Form 1120S instead of Form 1065.

As an employee, your salary is subject to social security and Medicare taxes (called FICA taxes).

However, net profit is not subject to social security and Medicare taxes. Net profit is subject to federal income taxes.

So, the idea is to pay yourself the lowest possible salary to minimize social security and Medicare taxes.

Then, you take the remaining net profit out of the business as a distribution (cut a check payable to yourself) which is subject to federal income taxes.

REMEMBER: You MUST be sure that the salary you pay yourself is considered reasonable for the work you're doing in your type of business.

If you pay yourself too little, a red flag will be raised. If audited, the IRS will claim that part of the profit you took out of the business was really wages and therefore, should be subject to social security and Medicare taxes.

Here's how this works:

Lets say your S-corporation has gross revenues of $50,000.
Your expenses, EXCLUDING YOUR SALARY, equal $10,000.
Now let's say you pay yourself an annual salary of $35,000.
- This leaves a net profit of $5,000 ($50,000 minus $45,000).
You take the remaining $5,000 as a distribution (you cut a check to pay yourself the $5,000).

Result:

FICA (social security and Medicare taxes) taxes would be paid on the $35,000 of wages (employee and employer each pay one half the FICA rate).
You would report gross wages of $35,000 and net profit of $5,000 on Form 1040.
Your total income of $40,000 would be reduced by your standard deduction (or itemized deductions, if greater) plus your personal exemption(s) to figure your taxable income.
Taxable income is subject to federal income tax.

How you save taxes:

Since you only paid yourself $35,000 instead of $40,000, only the $35,000 was subject to social security and Medicare taxes, not the $5,000 net profit.

The $5,000 net profit is subject to federal income taxes.

The tax savings is $765 (this does not take into account the 2011, 2% reduction in the social security rate because it's just a temporary reduction):

Social security and Medicare taxes (FICA taxes) on $5,000 is $765 ($5,000 x 15.3%.)

The 15.3% FICA rate represents both the employee's and employer's half of the tax (7.65% each). (As mentioned previously, the 2011, 2% rate reduction for social security taxes has not been taken into account.)

S-corporations: Deducting S-corporation Losses

Next >>

Startups

More Tax Topics

Quick Links

Hot Topics

Need Some Deductions for 2011?

Business Structures

<< Previous

How to Reduce Your FICA Taxes if You Own an S-corporation

Next:

Related Links