The tax benefit of operating as a S-Corp come into play when business profits exceed a reasonable salary for the owner.
Business owners are required to pay ~15% in Social Security (SS) and Medicare taxes. These taxes are collected differently for the sole proprietor compared to a S-Corp owner.
As a sole proprietor SS and Medicare taxes are paid on all business profits in the form of the self-employment tax.
As a S-Corp owner SS and Medicare taxes are only paid on the owner's wages. Distributions in excess of wages are not subject to these taxes.
All distributions from to a S-Corp owner must be in the form of wages until a reasonable salary has been paid.
Distributions in excess of the owners reasonable salary are not subject to SS and Medicare taxes, providing the saving over operating as a sole proprietor. A general example...
EXAMPLE | Sole Proprietor | S-Corp Owner |
Business Profits | $100,000 | $100,000 |
Wages | $0 | $70,000 |
Profit over Wages | $100,000 | $30,000 |
SS & Medicare Taxes | $15,300 | $10,710 |
There are additional expenses to operating as an S-Corp including payroll costs and preparation of a business tax return.