When running a self-employment business, there’s a fine line between your business and personal finances. A solo business tax move can have a dramatic effect on your own financial picture.
By setting up your self-employment business as a limited liability corporation (LLC), for example, is one of the first steps to making sure this line between the business and personal expands. But to ensure you can keep the profits within your business, consider an additional tax-centric move. Through an opt-in S-Corporation filing, even as a solo proprietor, you can ensure you pay a lot less in additional employment taxes.
It’s important to understand the benefits before considering such a move. Also, there’s a deadline for filing 2023 tax returns, which hits on March 15, 2023, in most cases. Addressing this issue now, can ease the impact of taxes come next April.
The S-Corp Opt-in
Under a solo organization or solo LLC, you have to pay your regular taxes. But you also have to pay Social Security and Medicare taxes. When you work as a regular employee, you pay half of these taxes and your employer pays the other half. Under a solo entrepreneurship design, you have to pay the full extent. This is an additional 7.65% that regular employees do not have to pay.
While you can write-off the amount, this still creates a significant additional tax burden. It’s often why people new to self-employment can be surprised by their tax bill that first year.
As an LLC, you’re essentially the business and the business is you. But there’s a tool called the S-Corp opt-in. This allows the LLC to operate like an S-Corp without having to manage many of the filings that an S-Corp demands. When you opt-in, however, you identify yourself as an employee of the organization. This has a dramatic effect on what you pay in your self-employment taxes.
The S-Corp Value
Now that you have a S-Corp designation, you’re technically an employee of the company. This allows you to pay yourself a salary. On that salary, you have to pay Social Security taxes and it’s taxed like regular income. But, here’s the key: You don’t have to pay yourself all of the profits that the organization makes.
This can be powerful. Say you make $120,000 in a year as a consultant. It’s possible to pay yourself, say $100,000. This means you don’t have to pay Social Security or Medicare taxes on the $20,000.
So what happens to the $20,000? That you can distribute to yourself as a distribution from the business. Since you own the company, it’s your profits for investing in the company. This $20,000 is taxed as regular income, but does not require additional payroll (Social Security or Medicare) taxes.
The Complications
While this is a fantastic tax advantage, you have to be careful about what you’re treating as salary. It needs to be reasonable, depending on what you do for a living. And the S-Corp may not work for certain situations.
But, if you think it might add value to your business, then consider digging into whether or not you should implement it. You can reach out to us if you need some help in that process.
Don’t delay though. It’ll make for a much easier 2023 tax season.
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