Last year, I mentioned my accountant saved me $15,000 by re-classifying my self-employment income from a limited liability corporation (LLC) to an S-corporation. I glossed over the process; in fact, getting to the $15,000 in tax savings was a bit more complicated than simply filing as an S-corporation. I could likely have saved even more if it hadn’t been too late to re-classify prior years, as well, or if I had worked with an accountant from the beginning.
I’ll share some details now so that readers — those with self-employment income, whether from a blog or otherwise — can determine whether this is the right choice for them. Keep in mind I am not an accountant or tax professional. Always discuss your particular situation with a tax accountant who will help you come to the right decisions.
An S-corporation is a type of legal business entity that, like LLCs or partnerships, allow all income or losses from a business to be passed along to shareholders and included in personal income tax returns. The biggest benefit, unlike LLCs or partnerships, is that not all business income needs to be passed to the owners as salary or wages.
For example, if you are the only shareholder, you could assign yourself a reasonable salary. You would owe self-employment tax on only this salary, not on your full business income. The remainder of your business profit will still be added to your personal income. You will owe income taxes on the full profit of the business, but only owe additional self-employment tax on the amount you designate as salary.
There are a few disadvantages for filing your business taxes as an S-corporation. The amount of necessary paperwork increases. If you’re busy running your business, you may not have time to deal with this. I’m glad I have a tax accountant to advise me and handle the paperwork. Considering the amount of money I saved, he has been worth his fee.
Filing as an S-corporation may make you more vulnerable to IRS audits, so ensure you’ve fully documented your income and deductions.
To create an S-corporation, complete your state’s process for incorporation and acquire a federal tax identification number. If you’ve already incorporated, or if you’ve formed an LLC, you do not need to re-incorporate, but ensure your state’s rules for your entity type meet your needs. File IRS form 2553 to elect S-corporation status.
When you file your taxes each year, rather than completing the form 1040 Schedule C, use form 1120S and Schedule K-1. Form 1120S is due before personal income taxes, so ensure your documentation has been sent in, or your extension request has been filed, by March 15 every year. Don’t forget to check your state filing requirements, too.
Updated December 21, 2010 and originally published November 8, 2010. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @flexo on Twitter and visit our Facebook page for more updates.