This is the third post in our series on issues which surround starting a business in Orange County, California. Our last post discussed choosing the right structure for your new business. How you structure your new enterprise will have an impact on taxation, liability, and more. In this post we will address an important topic – the fact that small business owners can save on taxes by starting an “S” Corporation. If you have questions about this issue then contact our office to speak with a Santa Ana business law lawyer.
Once one becomes a small business owner they have to deal with many issues which employees are used to being handled by their employer. Owning your own company means managing your own retirement plan, setting up your own health insurance, and ensuring that your quarterly tax payments are sent to the IRS. Many small business owners can utilize significant tax breaks which come from owning your own company but many fail to do so. One of these tax breaks is the way in which you can save on employment taxes by starting an S Corporation.
S Corporations get their name from the fact that they are created by section S of Chapter 1 of the federal tax code. They are considered “closely held” and are not publicly traded. These business entities pay no taxes of their own; taxes are “passed through” to the shareholders. This means that, for example, if an S Corporation had $100 in profit, then a fifty percent owner would show $50 in taxable income on their personal return ($100 profit x 50% ownership). A company does not have to be formed as an S Corp in order to be taxed as one. Say, for example, you start a Limited Liability Company (LLC) then you can elect to have your LLC taxed as an S Corp. Your company will remain an LLC but will be considered an S Corp solely for tax purposes.
A great benefit of electing to be an S Corp is that a business owner can save a great deal of money on employment taxes. This is because an S Corp owner must pay themselves a reasonable salary but profit in excess of that salary is exempt from employment taxes. Consider the following examples:
- Joe has a job for a company and earns a $100,000 annual salary. Joe will pay employment taxes (meaning social security and medicare tax) on the entire $100,000 amount.
- Jack owns an LLC, with no S Corp election, and the company earns a profit of $100,000. Jack will pay self employment tax (which is equivalent to social security and medicare tax) on the whole $100,000 amount.
- Jane owns an LLC but filed an S Corp election. She takes a $60,000 reasonable salary and the company earns $40,000 in profit after her salary. Jane will pay employment taxes on her wages but the $40,000 in profit is exempt from employment taxes.
- As you can see from the above examples, the owner of an S Corp can save a substantial amount of money in employment taxes.
As Santa Ana small business attorneys we regularly assist Orange County entrepreneurs with selecting and setting up a legal entity. We also provide ongoing support and can assist you in understanding whether your company is eligible to elect for S Corp treatment. Contact our office today to schedule an initial consultation. Our lawyers also service Aliso Viejo, Anaheim, Buena Park, Costa Mesa, Dana Point, Fountain Valley, Fullerton, Garden Grove, Huntington Beach, Irvine, La Habra, Ladera Ranch, Laguna Beach, Laguna Hills, Laguna Niguel, Lake Forest, Mission Viejo, Newport Beach, Orange, Placentia, Rancho Santa Margarita, San Clemente, San Juan Capistrano, Santa Ana, Tustin, Westminster, and Yorba Linda.