Business owners are constantly on the lookout for ways to cut down costs in order to improve their balance sheet. With the number of taxes that we are supposed to pay being law-abiding citizens of the United States, tips and tricks to save taxes are much sought-after by business owners. Tax attorneys who specialize in figuring out side alternatives to save on taxes for each specific business type are in high demand these days for precisely this reason.
The Trend of Sub S Taxation
For small business owners, an increasing trend of electing to be taxed as a Subchapter S corporation is being observed in the business world these days. Sub S Corporations can save a ton on social security and medicare taxes in the US, provided they are eligible to be taxed as such. Corporations with less than a hundred shareholders, which elect to be taxed under Subchapter S of the Internal Revenue Code, gain the benefit of being taxed as a partnership. This essentially translates to the corporation being able to avoid double taxation, and not having to pay tax on the total profit earned. Rather, each shareholder will be taxed individually.
Let’s take a look at a few tips that one should keep in mind to save on unnecessary taxes while being taxed as a Sub S Corporation.
Social Security Payroll Taxes
The IRS dictates that shareholders need to pay 15.3% self-employment tax on the salary they collect for services rendered to the Sub S Corporation. If you are running a small business and are the sole owner, you can minimize payroll taxes by setting your salary at a modest level. The IRS requires the salary to be reasonable considering your business’ income, so don’t set it too low!
There is another aspect to the payroll taxes though. To increase retirement benefits, you may want to pay more on the self-employment tax thus accruing Social Security wage credits. If you choose to opt for this route, limit your salary to a maximum of $106,800 per year. Social Security credits cannot be gained above this figure.
Offsetting Passive Losses
For tax purposes, income from a Sub S Corporation is treated as passive income. One might argue that this makes no sense since passive income implies ‘sitting around income’, while they have to go to work every day; but that’s just how it is, the IRS is not always logical. Anyway, this can work in your benefit, since now, you can offset passive losses, such as rental losses, by applying them to your Sub S income. This means, if your real estate properties report a loss of $15,000 on rentals, and your income bracket is $200,000, you will only have to pay tax for $185,000. The rental losses won’t even carry forward to future years!
While the advantages of electing to be taxed under Subchapter S are impressive, small business owners need to consider all aspects of the decision before making the change. All the caveats and paperwork should be discussed with a tax pro beforehand to avoid surprises later on.