Extra cost to become an S-corp vs sole proprietorship?

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jkushne1
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Extra cost to become an S-corp vs sole proprietorship?

Post by jkushne1 » Wed Nov 06, 2019 1:05 pm

I am currently a physician acting as an independent contractor, paid entirely on 1099 income. My income has slowly grown over the years. I have been told that I should consider switching my taxation status from a sole proprietor to an S-Corp to save on payroll taxes. Essentially I would save on the salary set aside as a distribution and for every 100k moved from salary--> distribution I would essentially save ~2900 (2.9%) on Medicare taxes since I would still be maxing out the social security component on salary alone. I do know that you are still required to pay yourself a "reasonable salary" so that isn't my question today.

My question is how much extra cost and effort is required to maintain an S-corp compared to sole proprietorship. I know there are other requirements, payroll, etc... Ideally my CPA would take care of all of that. I was wondering how much extra that typically costs to setup & ultimately maintain on an annual basis. For instance, if I save 2900 for every 100k in distribution and it costs an extra 1k/year in CPA fees, then I net 1900. If it costs 2500 then the profit isn't as beneficial of course.

DSInvestor
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Re: Extra cost to become an S-corp vs sole proprietorship?

Post by DSInvestor » Wed Nov 06, 2019 1:18 pm

When you're sole proprietor, you file a tax return (fed and state) for personal income tax that includes Schedules C and SE for your self employed income. When you're an S-Corp, your S-Corp will need file corporate tax return (1120S for fed and state equivalent). Your corporation will generate W-2 and K-1 both of which are used to flow into your personal tax return. As such there will be some additional cost to prepare these corporate tax returns, W-2, K-1 etc. I would not be surprised if your tax accountant charges $500-1000 or more for these depending on where you're located.

As an S-Corp, you will also pay yourself a salary which means that you may need some kind of payroll service to withhold fed/state tax, payroll taxes (social security, medicare), unemployment insurance etc. If memory serves me, there are some quarterly for the payroll taxes (941) and an annual federal unemployment (940) filing.

Your state may have an annual filing fee to maintain an S-Corp. Some states have low fees, some have high fees. For example, I believe California has an $800+/yr fee to maintain a corporation. Other states may have variable fees based on revenue or income.

Retirement plan contributions work differently if you're incorporated. For S-Corp with W-2 salary, solo 401k employee salary deferral contributions must be withheld from your paychecks during the year. This is a big difference from sole proprietor where salary deferrals can be made after the year is done up to tax filing deadline(s).
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Mullins
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Re: Extra cost to become an S-corp vs sole proprietorship?

Post by Mullins » Wed Nov 06, 2019 1:58 pm

As the sole shareholder of your S-Corp... you'll determine (along with a knowledgeable CPA) how much to pay yourself in wages which will be subject to payroll taxes and the balance comes to you as a dividend which is not subject to payroll taxes. But you will have to pay the employer's part of the wages' payroll taxes which essentially doubles the amount you'll pay into SS. Still, may not be a bad deal as you also may be able to write off expenses you're incurring which may not be as available to you as a sole proprietor. I think there are advantages to being a personal corporation both legal and financial.

As for state corporation taxes, you can incorporate in another state and pay them. Again, run all this through a CPA who knows this stuff.

Spirit Rider
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Re: Extra cost to become an S-corp vs sole proprietorship?

Post by Spirit Rider » Wed Nov 06, 2019 5:07 pm

OP keep in mind an S-Corp has to pay $420 ($7K * 6%) in state and federal unemployment insurance for each W-2 employee.
DSInvestor wrote:
Wed Nov 06, 2019 1:18 pm
Your state may have an annual filing fee to maintain an S-Corp. Some states have low fees, some have high fees. For example, I believe California has an $800+/yr fee to maintain a corporation. Other states may have variable fees based on revenue or income.
The CA franchise tax is 1.5% of the S-Corps ordinary income with an $800 minimum. So it effectively right off the bat reduces the 2.9% savings down to 1.4% or more if hit with the minimum.
Mullins wrote:
Wed Nov 06, 2019 1:58 pm
Still, may not be a bad deal as you also may be able to write off expenses you're incurring which may not be as available to you as a sole proprietor. I think there are advantages to being a personal corporation both legal and financial.
This is a myth. The are little to no business expenses that a typical S-Corp can take that a sole proprietorship can't.

Finally, the OP needs to be aware that an S-Corp's 2% shareholder-employee's Qualified Business Income (QBI) starts with their share of the S-Corp's ordinary income. A sole proprietor's QBI starts with sole proprietorship's business profit. An S-Corp will result in a substantially smaller QBI deduction.

The bottom line in the post TCJA tax environment (until sunset or repeal). If your taxable income is <= the QBI phaseout, an S-Corp is generally counter-productive and should be avoided. If your taxable income is >= the QBI phaseout, an S-Corp is generally beneficial. If you are IN the phaseout you have to extensively model it. If you have highly variable income, you are screwed.

Finally in CA, S-Corps are almost never advantageous until you get to upper six-figures.
Last edited by Spirit Rider on Wed Nov 06, 2019 6:17 pm, edited 1 time in total.

niceguy7376
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Re: Extra cost to become an S-corp vs sole proprietorship?

Post by niceguy7376 » Wed Nov 06, 2019 5:46 pm

Spirit Rider wrote:
Wed Nov 06, 2019 5:07 pm
The bottom line in the post TCJA tax environment (until sunset or repeal). If your taxable income is >= the QBI phaseout, an S-Corp is generally counter-productive and should be avoided. If your taxable income is >= the QBI phaseout, an S-Corp is generally beneficial.
Spirit RIder, I see both of them as greater than or Equal to.

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Mullins
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Re: Extra cost to become an S-corp vs sole proprietorship?

Post by Mullins » Thu Nov 07, 2019 9:52 am

I believe you can give yourself some fringe benefits over and above the salary and deductible for the S-Corp, which would be claimed as additional personal income yet not taxed for SS and medicare.

ralph124cf
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Re: Extra cost to become an S-corp vs sole proprietorship?

Post by ralph124cf » Thu Nov 07, 2019 2:47 pm

Reference California: If I remember correctly, Los Angeles has a 1% tax on gross receipts (not net income) of S Corps. A very unfriendly place for businesses.

Ralph

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Re: Extra cost to become an S-corp vs sole proprietorship?

Post by Vanguard Fan 1367 » Thu Nov 07, 2019 5:30 pm

I am a Florida Dentist. The fees here would be different than California. I pay 1000 a year for the tax return. The setup fees I don't remember.

In Florida if you are a corporation and you own your building you have to charge a reasonable rent to yourself and then pay 7 percent sales tax on that rent. The rent sales tax and the tax return fees and my slowing down after the Great Recession have made me wish I hadn't done the S Corp.

It is a pain for me to have to get the information together for the accountant to do the corporate return.

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