The Week's Big Idea: Incorporate

An S-corporation can be your form of incorporation or your tax designation. It costs more to set up and maintain. But if you are a highly profitable small business or solo entrepreneur, an S-corp is a wealth-building machine. 

Small business, big rewards

S-corps are best for highly profitable businesses with one or just a few owners, like freelance, consulting, software development, or high margin products.

S-corps give you the same risk protections as LLCs, but are more expensive to establish and have significantly more ongoing administrative requirements. You’ll need articles of incorporation, bylaws, and a shareholder agreement, and will hold regular board meetings with recorded and filed minutes.

So why would you do this? 

Fewer taxes means more money in your pocket

An S-corp designation is primarily about tax benefits. In an S-corp, you will be an owner-employee. You will pay yourself a reasonable salary. Beyond your salary, you can pass through additional profits to yourself as dividends. 

You are required to pay yourself a reasonable salary with payroll deductions. This gives you the first benefit: the company pays your self-employment tax. And since you are submitting to W-2 withholding each pay period, you don’t have to file quarterly taxes.

But here’s the biggest advantage: you can pay yourself additional profits above and beyond your salary as dividends. Dividends are not subject to payroll taxes like Medicare and Social Security. That's almost 16% more money for you.

If you are a highly profitable business, the salary + dividend structure of an S-corp may save you thousands of dollars a year in personal taxes. 

For costs, your business will need to file a separate tax return from your personal return. You will need to use a payroll company or calculate and file your own quarterly withholding in your state of incorporation. Expect to spend $5,000 in the first year and at least $2,500 in subsequent years.

An S-corp has a lot of restrictions that you should review. You must be a U.S. citizen or permanent resident to be a shareholder. 

One workaround to some S-corp setup costs is to set up an LLC and have it taxed as an S-corp. You can re-elect your LLC to S-corp tax status at the start of any tax year. If you decide this is the path for you, you’ll need to update a Form 8832 with the IRS and set up payroll for yourself.

If you are running a highly profitable solo or sole owner business, an S-corp (or LLC taxed as an S-corp) can be a very efficient way to build your personal wealth. Have this discussion with your business support team - it’s a great way to consider the future and build your relationships. 

Today's Assignment: how much is 16%?

How much would 16% more take home pay be for you? 

Coming up: C-corporations for unicorn dreams

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