S-CORP: How do taxes work?

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pepperz
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S-CORP: How do taxes work?

Post by pepperz » Thu Dec 21, 2017 3:28 pm

My company recently switched to S-Corp (from LLC)... my partner and I became W2 employees of this new entity.

Our compensation now gets taxes automatically taken out via payroll, which is convenient... but my question is:

What happens to business profits that we don’t take?

S-Corp tax liability passes through to owners which is fine, but what if we pay taxes on business profit and then LATER ON end up bonusing ourselves part of that amount?

Do we end up paying taxes twice? Once for the business and again when we take a distribution through payroll?

That doesn’t make sense with my understanding of SCORP. Please clarify.

omgbirdman
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Re: S-CORP: How do taxes work?

Post by omgbirdman » Thu Dec 21, 2017 3:35 pm

You do not pay taxes on distributions taken from the S-Corp. You pay tax on your share (based on stock ownership percentage) of the income at year end. It is essentially the same as an LLC, except you can now be paid wages.

One caveat is that any money that you take in excess of your share of the profits IS taxable income.

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MP123
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Re: S-CORP: How do taxes work?

Post by MP123 » Thu Dec 21, 2017 3:39 pm

You pay taxes on the profits whether they are distributed to you or not. The distributions themselves aren't taxable unlike dividends from a C Corp.

pshonore
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Re: S-CORP: How do taxes work?

Post by pshonore » Thu Dec 21, 2017 3:50 pm

You should receive a K1 form (generated by the S-Corp tax return) which will account for the profits allocated to you and possibly other income and expense items to complicate your personal 1040 return. That assumes you are still shareholders.

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StevieG72
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Re: S-CORP: How do taxes work?

Post by StevieG72 » Thu Dec 21, 2017 8:36 pm

S-Corp owner here.....

Typically S-Corp owners follow the IRS guidelines of paying themselves a W2 salary that is reasonable for the work performed and take the rest as a distribution.

This avoids paying excessive FICA tax. Distributions are free of FICA taxes.

Distributions are taxed as ordinary income on your personal return. S-Corp return is information only, no tax liabilty since it is a pass through entity.
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pepperz
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Re: S-CORP: How do taxes work?

Post by pepperz » Thu Dec 21, 2017 10:09 pm

Thanks everyone!

So here’s my understanding:

- tax liability for business profit passes through to the owners...

Example: if business makes $100K profit and there are two 50% shareholders, each owner is responsible for $50K on their personal tax return... even if they leave this $100K in the business and do not take a distribution personally.

- if later on, ie- 6 months after paying taxes - the owners DID end up taking that $100K as a distribution, zero taxes would be taken out - because the owners *already* paid taxes on that 100K 6 months before.

Do payroll systems already account for this or do you (the owner) have to notify them that no taxes should be taken out of this distribution?

Thanks!
StevieG72 wrote:
Thu Dec 21, 2017 8:36 pm
Distributions are taxed as ordinary income on your personal return. S-Corp return is information only, no tax liabilty since it is a pass through entity.

Jamesla30
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Re: S-CORP: How do taxes work?

Post by Jamesla30 » Fri Dec 22, 2017 2:44 am

pepperz wrote:
Thu Dec 21, 2017 10:09 pm
Thanks everyone!

So here’s my understanding:

- tax liability for business profit passes through to the owners...

Example: if business makes $100K profit and there are two 50% shareholders, each owner is responsible for $50K on their personal tax return... even if they leave this $100K in the business and do not take a distribution personally.

- if later on, ie- 6 months after paying taxes - the owners DID end up taking that $100K as a distribution, zero taxes would be taken out - because the owners *already* paid taxes on that 100K 6 months before.

Do payroll systems already account for this or do you (the owner) have to notify them that no taxes should be taken out of this distribution?

Thanks!
StevieG72 wrote:
Thu Dec 21, 2017 8:36 pm
Distributions are taxed as ordinary income on your personal return. S-Corp return is information only, no tax liabilty since it is a pass through entity.
,
Let me try to help as I think you are still confused. When you were set up as an LLC, you were taxed as a "partnership", which essentially means you both handle taxes like sole proprietors. Your income still flows through to your personal return and you pay regular income tax rates. However, as a partnership (2 sole proprietors) you also have to pay FICA (self employment) taxes, which is 15.3%. This is basically your contribution to social security and medicare, just like every else with a normal paycheck pays. You just have to pay it on all your business income. However, you do get to deduct 50% of the FICA taxes when calculating your income taxes. FICA taxes usually are paid half by the employer and half by the employee. Since you are just a business owner and not employee you pay the full amount, but that is also why you can take half of it as a deduciton.

Switching to a S-corp allows you to avoid some of these FICA taxes, so you don't pay the extra 15.3% on all of your income. You mentioned you switched from LLC to S-corp. Most people will actually remain an LLC, but "elect" to be treated as a s-corp for tax purposes. This election is essentially a form filed with the IRS. Technically you can be a straight up s-corporation as well. Both are treated the same, but the LLC requires alot less regular filings and paperwork.

The goal for tax advantages of an s-corp or llc w/ s-corp election is to pay yourself a regular salary, but minimize the salary as best as you can. You will only pay FICA tax on tha salary amount, the remaining business profit/income you do not pay fica taxes on.

So let's say you have $100k in total income, you pay $25k in salary, and have $75k profit left over. All $100k will flow to your individual return and you will pay normal income tax rates on that, but you will only have to pay 15.3% FICA taxes on the $25k salary. If you were not s-corp or llc w/ s-corp election, you would pay the same $100k income tax rates, but also 15.3% on the full $100k.

When you receive a paycheck, the FICA (15.3%) taxes are automatically deducted and taken out through payroll. However, absolutely no taxes are taken for the $75k, as this has nothing to do with your paycheck. You are required to make quarterly estimated tax payments to the government and state for the $75k.

The trick is that you have to pay yourself what is considered a "reasonable salary". If you are a lawyer or accountant, where most of your income is based off billing customers hourly for your work, it is difficult to claim a salary that is a great deal less than your total income. So if you are a lawyer making $500k/yr, you might be able to get away taking a $400k salary, and $100 as profit. However, if most of your income is based off of mark up of products that you sell, you can reasonably take a lower salary. In my business for example, I take a $60k salary and nearly $400k as profit. This is somewhat risky as it could trigger an audit, but i have documeted how I calculated my salary based off job duties and similar positions.

Hope that helps.... fire away with other questions.

Jamesla30
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Re: S-CORP: How do taxes work?

Post by Jamesla30 » Fri Dec 22, 2017 2:54 am

I should also mention that you never pay taxes when you take money out of the business. You can transfer money from your business account to your personal account without having to worry at all about taxes.

You pay taxes on the business profit, every year, regardless of when distributions are made (money is pulled out).

If you make $100k in profit (after salary) for a year, you will pay taxes on $100k. You can withdrawal it all at the end of the year and there is no additional tax. Or you can leave it within the business and withdrawal the $100k a year later. You would still have absolutely zero additional tax due at that time.

Just remember that you have to pay quarterly estimated taxes each quarter. Most people will have to pull money out of the business each quarter in order to make these estimated payments.

Some people get themselves in trouble because they think whatever money is left after a few months is all profit and all theirs. They don't realize they have to send a good chunk of that money to the govt for taxes.

Jamesla30
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Re: S-CORP: How do taxes work?

Post by Jamesla30 » Fri Dec 22, 2017 2:59 am

pepperz wrote:
Thu Dec 21, 2017 3:28 pm
Do we end up paying taxes twice? Once for the business and again when we take a distribution through payroll?
Payroll is only for your salary and nothing else. "Distributions" mean you are pulling out your profits from the business as the owner. These distributions are paid directly and not through payroll. You are now both an employee and owner. Your salary goes through payroll, your distribution of profits is just a check cut from the business directly to you as an owner.

pepperz
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Re: S-CORP: How do taxes work?

Post by pepperz » Fri Dec 22, 2017 8:56 am

Interesting! So technically I do NOT need to go through our payroll system in order to bonus anything above our salary?

That’s how we did it with LLC (just transfer bonus amounts straight from biz to personal bank accounts).

Our payroll system has a function for “bonus” and it automatically takes taxes out as part of that, which is what threw me off here.

Thank you!
Jamesla30 wrote:
Fri Dec 22, 2017 2:54 am
I should also mention that you never pay taxes when you take money out of the business. You can transfer money from your business account to your personal account without having to worry at all about taxes.

omgbirdman
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Re: S-CORP: How do taxes work?

Post by omgbirdman » Fri Dec 22, 2017 9:39 am

pepperz wrote:
Fri Dec 22, 2017 8:56 am
Interesting! So technically I do NOT need to go through our payroll system in order to bonus anything above our salary?

That’s how we did it with LLC (just transfer bonus amounts straight from biz to personal bank accounts).

Our payroll system has a function for “bonus” and it automatically takes taxes out as part of that, which is what threw me off here.

Thank you!
Bear in mind that your distributions have to be proportional. If you are 50/50 owners, one owner cannot take a 70k distribution while the other only takes a 50k.

Atgard
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Re: S-CORP: How do taxes work?

Post by Atgard » Fri Dec 22, 2017 10:35 am

pepperz wrote:
Fri Dec 22, 2017 8:56 am
Interesting! So technically I do NOT need to go through our payroll system in order to bonus anything above our salary?

That’s how we did it with LLC (just transfer bonus amounts straight from biz to personal bank accounts).

Our payroll system has a function for “bonus” and it automatically takes taxes out as part of that, which is what threw me off here.

Thank you!
Jamesla30 wrote:
Fri Dec 22, 2017 2:54 am
I should also mention that you never pay taxes when you take money out of the business. You can transfer money from your business account to your personal account without having to worry at all about taxes.
That's right, you would use the bonus feature through payroll if you wanted to give yourself a bonus on your W-2 salary... in other words increasing your W-2 salary for the year. (And paying FICA taxes on it.)

Just for clarity, paying yourself $50,000 in W-2 salary with a $10,000 bonus at the end of the year will be exactly the same as paying yourself $60,000 in W-2 salary and no bonus. But that is DIFFERENT (mainly due to FICA) than paying yourself $50,000 in W-2 salary and then keeping an extra $10,000 in business profit (which avoids FICA and which you can withdraw from the company whenever you feel like it, but you get taxed the year it's earned).

That is the difference between salary/bonus (reported on a W-2 as taxable wage income, just like you worked for any other company) vs. distributions (which are taxed at the end of the year when earned, not when distributed, flow through to your personal return, but you do not pay FICA taxes on them).

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Re: S-CORP: How do taxes work?

Post by Atgard » Fri Dec 22, 2017 10:43 am

Also, Jamesla30 gave some excellent info above, but I just wanted to repeat: a lot of people get confused with this, but an LLC is a state designation of the type of business entity. Then you can have that LLC just taxed as a normal pass-through entity (meaning you file a Schedule C on your personal return for the earnings), or elect to be taxed as an S-Corp (by filing Form 2553 with the IRS), and then you need to file an S-Corp return (Form 1120S) in addition to your personal return each year.*

So the proper term (assuming this is what you're doing and you filed Form 2553 with the IRS) is an LLC taxed as an S-Corp. Using the right terminology may help when discussing it or searching for info.

* Also note the deadline for the S-Corp tax return is MARCH 15 (not April 15), and it will generate a Form K-1 that gets stuck onto your personal return. I missed this deadline the first year, but when I called the IRS they were kind enough to waive the late fee.

pepperz
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Re: S-CORP: How do taxes work?

Post by pepperz » Fri Dec 22, 2017 10:56 am

Thank you! As owners of the business why would we ever want to “bonus” ourselves through payroll when it’s cheaper to take distributions?

I take it “bonus” is for non-owner employees and “distributions” are for owners.
Atgard wrote:
Fri Dec 22, 2017 10:35 am
That's right, you would use the bonus feature through payroll if you wanted to give yourself a bonus on your W-2 salary... in other words increasing your W-2 salary for the year. (And paying FICA taxes on it.)

betablocker
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Re: S-CORP: How do taxes work?

Post by betablocker » Fri Dec 22, 2017 10:56 am

pepperz wrote:
Fri Dec 22, 2017 8:56 am
Interesting! So technically I do NOT need to go through our payroll system in order to bonus anything above our salary?

That’s how we did it with LLC (just transfer bonus amounts straight from biz to personal bank accounts).

Our payroll system has a function for “bonus” and it automatically takes taxes out as part of that, which is what threw me off here.

Thank you!
Jamesla30 wrote:
Fri Dec 22, 2017 2:54 am
I should also mention that you never pay taxes when you take money out of the business. You can transfer money from your business account to your personal account without having to worry at all about taxes.
To be clear you are not bonusing anything. A bonus goes through payroll and FICA tax is deducted. You wan to write a check from the bank account to yourself and record it as a distribution. The only reason to bonus is to give different amounts to owners than their equity percentage. Also the social security amount of FICA stops in the low $100,000s. After that you are saving only the Medicare tax 1.45%.

betablocker
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Re: S-CORP: How do taxes work?

Post by betablocker » Fri Dec 22, 2017 11:03 am

Correction. The total Medicare tax is 2.9%-1.45 from the employee and company each.

DSInvestor
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Re: S-CORP: How do taxes work?

Post by DSInvestor » Fri Dec 22, 2017 11:08 am

If you plan on using Solo 401k for your S-Corp, please be aware that the solo 401k for the S-Corp must be established by 12/31/2017 in order for it to accept contributions for tax year 2017. Now that you're W-2 employees of the S-Corp, your Solo 401k employee salary deferral contributions must be withheld from your paychecks by 12/31 and there isn't much time left for 2017 paychecks.
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pepperz
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Re: S-CORP: How do taxes work?

Post by pepperz » Fri Dec 22, 2017 5:18 pm

I wish we could use Solo 401K but we do have other W2 employees besides just us.

Hoping we can find a plan that allows after tax contributions and yearly conversions. But that’s for another thread. :)
DSInvestor wrote:
Fri Dec 22, 2017 11:08 am
If you plan on using Solo 401k for your S-Corp, please be aware that the solo 401k for the S-Corp must be established by 12/31/2017 in order for it to accept contributions for tax year 2017. Now that you're W-2 employees of the S-Corp, your Solo 401k employee salary deferral contributions must be withheld from your paychecks by 12/31 and there isn't much time left for 2017 paychecks.

pepperz
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Re: S-CORP: How do taxes work?

Post by pepperz » Fri Dec 22, 2017 8:17 pm

Thank you to everyone who helped me get to the bottom of this!

FYI if my followup question on 401K interests you please feel free to participate in this thread I just started.

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Sparky1500
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Re: S-CORP: How do taxes work?

Post by Sparky1500 » Fri Dec 22, 2017 9:19 pm

I am a single-owner of a dental practice operating as an S-corp. Does it make sense to return dividends paid out to me this month and instead use those funds to pre-pay 2018 expenses in order to take into account the new tax law changes?
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Re: S-CORP: How do taxes work?

Post by Spirit Rider » Fri Dec 22, 2017 10:03 pm

Sparky1500 wrote:
Fri Dec 22, 2017 9:19 pm
I am a single-owner of a dental practice operating as an S-corp. Does it make sense to return dividends paid out to me this month and instead use those funds to pre-pay 2018 expenses in order to take into account the new tax law changes?
As has been all over the news recently an S-Corp is a pass-thru entity, it does not pay dividends. It has "distributions", which are taxable income "allocations" of the ordinary business income of the S-Corp. This income flows through to an S-Corp shareholder on their personal Form 1040 Line 17.

It is irrelevant whether the funds are actually "distributed", distributed and returned or never distributed in the first place. The income is still going to stick in Line 17.

Jamesla30
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Re: S-CORP: How do taxes work?

Post by Jamesla30 » Sat Dec 23, 2017 3:44 am

Sparky1500 wrote:
Fri Dec 22, 2017 9:19 pm
I am a single-owner of a dental practice operating as an S-corp. Does it make sense to return dividends paid out to me this month and instead use those funds to pre-pay 2018 expenses in order to take into account the new tax law changes?
What's your income level?

ig77
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Re: S-CORP: How do taxes work?

Post by ig77 » Sat Dec 23, 2017 9:49 am

This is an excellent thread. As a new S-Corp owner, the information helped me answer a lot of questions I had.

I am still confused about taxes on distributions. In the example used in a previous post, how is $75000 taxed? Does the S-Corp pay taxes on this amount when quarterly estimated taxes are paid? Or since it shows up in 1040 for the individual, does the taxes get paid at the end of the year when filing the personal return?

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Sparky1500
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Re: S-CORP: How do taxes work?

Post by Sparky1500 » Sat Dec 23, 2017 10:10 am

Spirit Rider wrote:
Fri Dec 22, 2017 10:03 pm
Sparky1500 wrote:
Fri Dec 22, 2017 9:19 pm
I am a single-owner of a dental practice operating as an S-corp. Does it make sense to return dividends paid out to me this month and instead use those funds to pre-pay 2018 expenses in order to take into account the new tax law changes?
As has been all over the news recently an S-Corp is a pass-thru entity, it does not pay dividends. It has "distributions", which are taxable income "allocations" of the ordinary business income of the S-Corp. This income flows through to an S-Corp shareholder on their personal Form 1040 Line 17.

It is irrelevant whether the funds are actually "distributed", distributed and returned or never distributed in the first place. The income is still going to stick in Line 17.
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Sparky1500
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Re: S-CORP: How do taxes work?

Post by Sparky1500 » Sat Dec 23, 2017 11:11 am

Sparky1500 wrote:
Fri Dec 22, 2017 9:19 pm
I am a single-owner of a dental practice operating as an S-corp. Does it make sense to return dividends paid out to me this month and instead use those funds to pre-pay 2018 expenses in order to take into account the new tax law changes?
One last thing, please. Does the additional fact/clarification that the 2018 expenses that I am talking about pre-paying with the returned December distributions are 2018 business expenses (not personal expenses)? Would that not reduce the amount on the 1040 line 17? Trying to get my head around all of this....thanks.
Retired August 3, 2018 and very grateful.

pshonore
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Re: S-CORP: How do taxes work?

Post by pshonore » Sat Dec 23, 2017 12:26 pm

ig77 wrote:
Sat Dec 23, 2017 9:49 am
This is an excellent thread. As a new S-Corp owner, the information helped me answer a lot of questions I had.

I am still confused about taxes on distributions. In the example used in a previous post, how is $75000 taxed? Does the S-Corp pay taxes on this amount when quarterly estimated taxes are paid? Or since it shows up in 1040 for the individual, does the taxes get paid at the end of the year when filing the personal return?
You can call it what you want but I'm going to call it money left after expenses including salaries are paid. S Corps generally do not pay taxes. The S Corp does produce a tax return (Form 1120) and a K1 form for each owner. The K1 form shows the money left which goes on each owners K1 proportionally and winds up om their 1040. It also can show other items of income and expense. I've seen S Corp K1 forms that passed through a DAPD (Domestic Activities deduction), interest income, cap gains, credits for small employer health insurance, Section 179 deductions, etc. If you anticipate a large "share of profits", you may want to pay estimated tax on them

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MP123
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Re: S-CORP: How do taxes work?

Post by MP123 » Sat Dec 23, 2017 12:36 pm

Sparky1500 wrote:
Sat Dec 23, 2017 11:11 am
Sparky1500 wrote:
Fri Dec 22, 2017 9:19 pm
I am a single-owner of a dental practice operating as an S-corp. Does it make sense to return dividends paid out to me this month and instead use those funds to pre-pay 2018 expenses in order to take into account the new tax law changes?
One last thing, please. Does the additional fact/clarification that the 2018 expenses that I am talking about pre-paying with the returned December distributions are 2018 business expenses (not personal expenses)? Would that not reduce the amount on the 1040 line 17? Trying to get my head around all of this....thanks.
Assuming that you operate on a cash basis then paying more expenses this year (2017) will reduce your net profit on line 17. If you don't need to pay the expenses again in 2018 then your net profit on line 17 for 2018 will be higher if all else is equal.

Are the expenses you're considering prepaying substantial? Will you be eligible for the 20% Section 199a deduction in 2018 based on total taxable income? What tax bracket will you be in for 2017 and for 2018? You'd need to know all that to calculate any possible savings from accelerating the payments.

My guess is that unless we're talking about a lot of expenses it probably isn't worth it.

Edit: I'll add that there are significant changes in the area of capital expensing starting in 2018. So if your expenses are something that you would normally have to depreciate you may be able to expense it right away next year and show even less profit then. Just to further complicate things! :wink:

Jamesla30
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Re: S-CORP: How do taxes work?

Post by Jamesla30 » Sat Dec 23, 2017 1:22 pm

Sparky1500 wrote:
Fri Dec 22, 2017 9:19 pm
I am a single-owner of a dental practice operating as an S-corp. Does it make sense to return dividends paid out to me this month and instead use those funds to pre-pay 2018 expenses in order to take into account the new tax law changes?
It depends on what tax bracket you are in. Generally speaking though, your tax rate will probably go down starting next year... So YES, it probably makes sense for you to push AS MUCH expense into this year as you can. You will more than likely save more taxes by doing this since your tax rate will be higher this year than next year. So you want as much deduction (expense) this year as you can do. This essentially shifts profit/income from this year into next year (which will be taxed at a lower rate than it would have this year).

Jamesla30
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Re: S-CORP: How do taxes work?

Post by Jamesla30 » Sat Dec 23, 2017 1:27 pm

ig77 wrote:
Sat Dec 23, 2017 9:49 am
This is an excellent thread. As a new S-Corp owner, the information helped me answer a lot of questions I had.

I am still confused about taxes on distributions. In the example used in a previous post, how is $75000 taxed? Does the S-Corp pay taxes on this amount when quarterly estimated taxes are paid? Or since it shows up in 1040 for the individual, does the taxes get paid at the end of the year when filing the personal return?
The $75,000 is taxed just like your salary is taxed (at normal individual income tax rates). All income, whether from your s-corp salary, or business profits you pull out of the business as an owner, is taxed at indivudal tax rates. There is no seperate taxes or corporate rates that s-corp owners pay. Ignore all of that. You only have to focus on individual tax rates, as all your income flows to your personal taxes.

Keep in mind you pay tax on the full $75k of business profit, it doesn't matter whether you pull it out of the business, or not.

You are required by law to make individual/personal estimated tax payments each quarter. If you want until the end of the year to pay everything, you will not only be suprised by how much you owe in taxes, but you will also have to pay a pretty significant penalty to the IRS (and maybe state) because you didn't make estimated quarterly payments.

I usually figure out what my business profit (net income) is each quarter, and then estimate what my effective tax rate will be. So if I paid about 30% taxes the previous year, and income hasn't changed dramastically, I will make estimated quarterly payments of 30% of my business income/profit. Don't worry about including your salary, these estimated payments are automatically withdrawn and made through payroll.

Jamesla30
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Re: S-CORP: How do taxes work?

Post by Jamesla30 » Sat Dec 23, 2017 1:30 pm

Sparky1500 wrote:
Sat Dec 23, 2017 11:11 am
Sparky1500 wrote:
Fri Dec 22, 2017 9:19 pm
I am a single-owner of a dental practice operating as an S-corp. Does it make sense to return dividends paid out to me this month and instead use those funds to pre-pay 2018 expenses in order to take into account the new tax law changes?
One last thing, please. Does the additional fact/clarification that the 2018 expenses that I am talking about pre-paying with the returned December distributions are 2018 business expenses (not personal expenses)? Would that not reduce the amount on the 1040 line 17? Trying to get my head around all of this....thanks.
Since you are s-corp, your business expenses flow to your personal tax return, so they are essentially the same thing. Contributing $10k to an IRA will lower your taxable income by $10k. Paying $10k of expenses in your business will also lower your taxable income by $10k because you now have $10k less in business profits that will flow to your personal taxable income amount.

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Re: S-CORP: How do taxes work?

Post by theplayer11 » Sat Dec 23, 2017 1:38 pm

Jamesla30 wrote:
Sat Dec 23, 2017 1:27 pm
ig77 wrote:
Sat Dec 23, 2017 9:49 am
This is an excellent thread. As a new S-Corp owner, the information helped me answer a lot of questions I had.

I am still confused about taxes on distributions. In the example used in a previous post, how is $75000 taxed? Does the S-Corp pay taxes on this amount when quarterly estimated taxes are paid? Or since it shows up in 1040 for the individual, does the taxes get paid at the end of the year when filing the personal return?
The $75,000 is taxed just like your salary is taxed (at normal individual income tax rates). All income, whether from your s-corp salary, or business profits you pull out of the business as an owner, is taxed at indivudal tax rates. There is no seperate taxes or corporate rates that s-corp owners pay. Ignore all of that. You only have to focus on individual tax rates, as all your income flows to your personal taxes.

Keep in mind you pay tax on the full $75k of business profit, it doesn't matter whether you pull it out of the business, or not.

You are required by law to make individual/personal estimated tax payments each quarter. If you want until the end of the year to pay everything, you will not only be suprised by how much you owe in taxes, but you will also have to pay a pretty significant penalty to the IRS (and maybe state) because you didn't make estimated quarterly payments.

I usually figure out what my business profit (net income) is each quarter, and then estimate what my effective tax rate will be. So if I paid about 30% taxes the previous year, and income hasn't changed dramastically, I will make estimated quarterly payments of 30% of my business income/profit. Don't worry about including your salary, these estimated payments are automatically withdrawn and made through payroll.
or maybe just increase withholding through payroll to avoid estimated tax

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Re: S-CORP: How do taxes work?

Post by dmcmahon » Sat Dec 23, 2017 1:45 pm

What if you're just starting your business and for a few years you aren't making any money? How can you make that work vis-a-vis the requirement to pay yourself a reasonable salary? Are you allowed to work for nothing for a while? Even with C corps there are cases where for symbolic reasons the CEO pays himself a $1 salary. There have also been cases where companies allowed employees to take shares of stock in lieu of a salary to save themselves cash during a startup period.

Jamesla30
Posts: 57
Joined: Sat Jan 14, 2017 3:41 pm

Re: S-CORP: How do taxes work?

Post by Jamesla30 » Thu Dec 28, 2017 2:44 pm

theplayer11 wrote:
Sat Dec 23, 2017 1:38 pm
Jamesla30 wrote:
Sat Dec 23, 2017 1:27 pm
ig77 wrote:
Sat Dec 23, 2017 9:49 am
This is an excellent thread. As a new S-Corp owner, the information helped me answer a lot of questions I had.

I am still confused about taxes on distributions. In the example used in a previous post, how is $75000 taxed? Does the S-Corp pay taxes on this amount when quarterly estimated taxes are paid? Or since it shows up in 1040 for the individual, does the taxes get paid at the end of the year when filing the personal return?
The $75,000 is taxed just like your salary is taxed (at normal individual income tax rates). All income, whether from your s-corp salary, or business profits you pull out of the business as an owner, is taxed at indivudal tax rates. There is no seperate taxes or corporate rates that s-corp owners pay. Ignore all of that. You only have to focus on individual tax rates, as all your income flows to your personal taxes.

Keep in mind you pay tax on the full $75k of business profit, it doesn't matter whether you pull it out of the business, or not.

You are required by law to make individual/personal estimated tax payments each quarter. If you want until the end of the year to pay everything, you will not only be suprised by how much you owe in taxes, but you will also have to pay a pretty significant penalty to the IRS (and maybe state) because you didn't make estimated quarterly payments.

I usually figure out what my business profit (net income) is each quarter, and then estimate what my effective tax rate will be. So if I paid about 30% taxes the previous year, and income hasn't changed dramastically, I will make estimated quarterly payments of 30% of my business income/profit. Don't worry about including your salary, these estimated payments are automatically withdrawn and made through payroll.
or maybe just increase withholding through payroll to avoid estimated tax
That would acheive the same goal, but for many their payroll is not high enough by itself to cover the additional tax due. Most have to pull out profits and use that to pay the additional tax due.

Plus that makes things more complicated. I find it easier to let my payroll stay the same each month. That will assure my withholding for salary is roughly correct, and then i can just make the additional estimated payments based off a rough percentage of business profit every quarter. This will take care of flucuations in profit each quarter without messing with payroll.

Jamesla30
Posts: 57
Joined: Sat Jan 14, 2017 3:41 pm

Re: S-CORP: How do taxes work?

Post by Jamesla30 » Thu Dec 28, 2017 3:09 pm

dmcmahon wrote:
Sat Dec 23, 2017 1:45 pm
What if you're just starting your business and for a few years you aren't making any money? How can you make that work vis-a-vis the requirement to pay yourself a reasonable salary? Are you allowed to work for nothing for a while? Even with C corps there are cases where for symbolic reasons the CEO pays himself a $1 salary. There have also been cases where companies allowed employees to take shares of stock in lieu of a salary to save themselves cash during a startup period.
The IRS generally looks at two things:

1. The ratio of salary to distributions. Safe would be 10:1, risky would be 1:10. So if you take a $10,000 salary and $100,000 distributions, that could get flagged for an audit. $100k salary and $10k distribution would definitely not.

2. They will also look at the specific job/business you are in. Duties, education required, experience, etc. Basically think of it this way -- if you had to pay someone else to do your job, how much would you have to pay them?
-- if you are a CPA or lawyer and made $200k working 40 hours/week, you cannot set up an s-corp and pay yourself $50k and take $150k distributions -- the IRS would argue you cannot hire a full time CPA and pay them $50k/yr, that would be a bookeepers salary. They would probably argue $125k minimum for salary based off of average CPA salaries in your area.
-- if you are a person that has a business selling a product, and most of your profit is based off of margins on that product you would be on the other end. You are essentially a salesman/warehouse shipper, etc. You would have an easier time arguing a lower ratio (maybe $50k salary and $150k distribution) because you could argue that you can hire someone to do your job for that $50k salary.

So to answer your question, you would be fine paying yourself zero (or very low) salary if you have no profits (distributions). C-corps aren't required to pay "reasonable salaries", because they actually are worse off paying low salaries (or at least used to be before this tax reform). This only applies in s-corps because the lower the salary, the less 15.3% employment taxes that person saves.

Lastly I will mention this only applies to the salary of the owner, mainly in single owner/employee s-corps. You can pay your employees whatever you want. A CPA isn't going to take a job unless you pay them market rates :)

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