Nevada Corporate Services.com

Question

My husband is currently operating as a sole-proprietorship in our home based plumbing/appliance repair business. We are seeking a way to reduce our self-employment tax liability. Is forming an S-corporation a sensible way to accomplish this? My understanding is that profits or losses from the business would flow directly through to the shareholder's (in this case, it would be my husband's) 1040 form (bypassing the schedule C). Also, would the corporation pay my husband a wage as if he were an employee? If so, would we have to pay FICA and similar employer-paid taxes on the "wage"? What about W-2 forms? How would this work?

Conventional wisdom recommends that a Sub-S "COULD" reduce your payroll taxes, SLIGHTLY. It does this by splitting the income into earned and passive. Earned income is subject to payroll taxes, passive income is not.

You have all the key points, now you have to meld them into a working system.

Yes, you would still be on payroll, and the payroll portion would still have to pay ALL of the payroll taxes (FICA, etc.)

You could take PART of the total income as passive income (distribution to shareholder) and that part would not be subject to FICA.

HOWEVER, the kicker is: "How much" can you take passively?

First, you would need to take a reasonable; which in your business could be 40% of what he is actually making or 100% of what he is making. That depends upon industry standards. For example, what could he make as an employee doing all of the same functions, not just repairs, but the management also, in that industry? And how many hours does he work at that business? Then you can evaluate his position compared to the industry.

Next, your wage must be reasonable for that business, some businesses are highly profitable, and the IRS expects you to pay payroll taxes on much of it. Conventional wisdom says that at least 50% needs to be "earned".

If your income is too low, you won't get any benefit from the Sub-S.

But for many business owners this seems to be great, BUT...

Even for high income business owners, the Sub-S won't do much. You see, once you exceed $102,000 (social security limit for 2008) of income, you stop paying social security anyway. So you only save Medicare, which is 2.9%. So for someone making $204,000 (twice the social security cutoff), the only savings would be 1.45% (1/2 of the Medicare).

And you still have severe limits on what your business can deduct. Sub-S cannot deduct medical expenses for owners, for example.

Do business as all of the most successful businesses do. Do business as a real corporation. You get better write-offs and deductions, you can still reduce your income and your payroll taxes, but you can do it better because a real corporation does not have the restrictions listed above. AND any extra money, instead of being taxed at your personal income tax level, would be taxed lower at the corporate level.