Karen Baszak, CFP® explains the considerations regarding the legal structure of your business: liability, taxes and cost, and how these aid in your decision to establish an S corporation for your business.
“Hi, I’m Karen Baszak, CERTIFIED FINANCIAL PLANNER™ with Pure Financial Advisors, and this is the Question of the Week.
This week’s question is: When should I establish an S corporation for my business? Many of my clients are small business owners who report their business income on schedule C of their tax return. The question that often comes up is: when should I consider changing the structure of my business to an S corporation? Well, there are many things that need to be considered regarding the legal structure of your business; the three primary considerations are liability, taxes and cost. We’re going to take a closer look at these issues today.
When it comes to liability, an S corporation will not offer you protection from your own personal liability, but it will offer you protection from the misdeeds or negligence of your employees. If you have employees other than your spouse, and you’re concerned about the potential liability risk that they pose to you, then you may wish to establish an S corp for this reason, that way your personal assets will have some level of protection.
The second consideration is payroll taxes, also known as FICA taxes. When you report your income under schedule C, your income will be subject to FICA taxes which are typically assessed at a rate of 15.3%. The FICA taxes are in addition to your federal and state income taxes. With an S corporation, you are typically able to split your income into two separate categories, the first is W-2 income which is basically the salary you pay yourself. The second is K-1 income, which consists of the profits you receive from the company. In this instance, the K-1 income is not subject to FICA taxes, so you can see that you could end up paying considerably less with an S corporation, compared to reporting your income under a Schedule C.
The final consideration is cost. An S corporation has both startup and ongoing legal and accounting costs. The state of California will charge a state franchise tax fee of $800 a year, and in addition to this fee, you can expect charges from your CPA to prepare the S corporation return, which could run $1,000 per year or more. So if you’re setting up the S corporation solely to save money on taxes, you want to make certain that the tax savings warrant the additional cost. As with any tax matter, you should always consult a qualified tax professional for guidance.
I’m Karen Baszak, and that was the Question of the Week.”