Considering an S Corp? Here’s how to determine if it’s right for you.

Our Head of Tax Advisory Kristin Carter, CPA has nearly 20 years of expertise in tax compliance and planning, and spearheads our tax advisory team. Her mission: to make the ins and outs of taxes approachable and exciting. She’s the most passionate person about taxes we know, and one of the most fun. 

If your business is growing, congrats! You’re getting some great income. But it doesn’t have to stop here — you can make gains way beyond your regular balance sheet. 

That’s where an S Corp election comes in: It brings some huge tax savings that can supercharge your business — and that’s all money you can put back into your business or towards growing your retirement funds, instead of handing it to the IRS. 

Today, you’ll  hear how to navigate a potential change. ‍

The Role S Corps Play in Tax Savings

As your business grows, you'll want to pick a structure that keeps more cash in your pocket. If you're running a single-member LLC or just operating as a sole proprietor, you probably already know that when you make more income, you’ll start paying significant self-employment taxes (15.3%, actually) on top of your income taxes.

Usually, most founders end up choosing between an LLC and an S Corp. One exception: If they’re in an industry that can take advantage of QSBS (qualified small business stock) status, a C Corp is the way to go. 

Once your business starts pulling in serious money (think $100,000+), switching to an S Corp can save you a decent chunk of taxes. Here's the deal: With an S Corp, you pay yourself a "reasonable salary." When you have a reasonable salary, you still pay self-employment tax on that amount. However, everything above that threshold escapes self-employment taxes. 

Think of an S Corp as the sweet spot between a basic LLC and the more-complicated C Corp — you get solid tax breaks plus the flexibility to adapt as your business evolves.

If you're wondering when those S Corp tax savings actually make sense (especially when you factor in all the extra paperwork), and what hoops you'll need to jump through to make the switch, we’re here to help. Below, you’ll find a simple process to gut-check whether it’s the right time for you.

How to Evaluate Whether an S Corp is Right for You

Every business is different. The following steps will help you consider what your needs are right now and how an S Corp might help. 

Step 1: Ask yourself whether your business is here for the long-term, or if it’s a side hustle

Maybe you were just working on a side hustle and it grew faster than you imagined. It was a fun hobby that’s become serious, and now you’re invested for the long term. Or maybe you’re just waiting for a little more proof of success before you make the S Corp switch. 

If you’re invested in your business for the long term, then transitioning to an S Corp is an option worth considering — especially if you’re making six figures and up (more on that in Step #2). 

If you’re not super serious about this being a full-time business, and you’re not willing to do the payroll, the extra tax return, and all that stuff — then an S Corp may not be worth it for you.
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For short-term side hustles, you might want to stick to an LLC. LLCs offer the legal protection you need, are easy to set up, and have an easier tax process than an S Corp. Plus, you always have the ability to switch to an S Corp later on in your business’s journey. 

When you decide you’re ready to be taxed as an S Corp, you just file an election form with the IRS. 

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‍Step 2: Evaluate when your business crosses the income threshold

When you’re determining whether your business is making enough money to consider transitioning to an S Corp, take a look at the numbers. 

If you haven’t transitioned to an S Corp yet, look at how much you paid in taxes for the previous year, and calculate how much you could save the next year if you change elections. 

A rule of thumb: If your business income is high and your tax bill is, too, it’s time to strategize ways to minimize. New clients are often paying 15.3% in self-employment taxes on top of a 35-37% tax bracket — that’s a recipe for a painful EOY tax bill.

A six-figure threshold is where an S Corp becomes worthwhile. If you're making $150,000 as an LLC, you're paying 15.3% self-employment tax on top of your income tax rate. That means you're paying close to $23,000 in self-employment taxes alone! But if your reasonable salary as an S Corp is set at $50,000, the additional $100,000 in LLC income escapes self-employment tax.

Sounds like you just saved a lot of money. You can thank yourself for making a financial decision that’ll pay off for years to come. 

Our dashboard helps business owners like you figure out how different salary levels and entity structures affect their taxes and net worth. We can input any mock scenario to help you see how a change in entity structure and the resulting taxes (or reduction in taxes) would impact your financial goals.

When all the numbers are right in front of you, it makes the decision that much easier. 

I educate our clients on the risks and benefits of different salary thresholds. Below are some of the IRS resources that can help guide you in setting a reasonable salary: 

• Things to know about paying yourself.
• More information about S Corps’ employees, shareholders and corporate officers.
• Compensation and medical insurance for S Corps. 
• Tips for deciding on your reasonable compensation. 

If you decide to transition to an S Corp, these are the next steps:

Step 3: File for S Corp tax treatment

To transition your company to an S Corp, all you have to do is file IRS Form 2553. You don’t need to create a new entity: All you’re doing is changing the way your LLC is treated taxwise.

One thing to note: Timing matters. You have to file that form with specific deadlines in mind (according to the tax year).

Those deadlines are no more than two months and 15 days after the beginning of the tax year the election is to take effect, OR at any time during the tax year preceding the tax year that the change will take effect.

Step 4: Set up the necessary infrastructure

Once the IRS confirms your S Corp status, you have to start paying payroll to yourself. That means using a payroll service and filing quarterly payroll tax returns.

Other infrastructure moves might include setting up processes for the additional S Corp tax return (separate from your personal return).

My clients have access to tax planning and strategy as well as the Compound dashboard that illustrates how their taxes and other financial decisions impact their life goals. 

We try to be the one-stop-shop for everything a client needs for their financial life.

Sometimes, this also means getting all the right people “in the room”. Any individual thinking about establishing an S Corp or LLC often also needs a tax preparer. This is when we usually talk about our tax filing options and our network of vetted, best-in-class CPAs and tax providers.

Sometimes there’s an investment advisor, tax advisor, and a CPA all on one call. (Just imagine if your primary care doctor, ENT, and neurologist all got together to chat about what’s best for you. Wouldn’t that make big-picture financial wellness so much easier?) 

When you get all the different parties involved in your financial planning on the same page, it helps streamline the flow of information, ensure the tax return is done appropriately, and protects your client’s best interest.  

We’re always ready to jump on a call with our client and the CPA firm. We’re our client’s tax quarterback. 

The Compounding Effects of S Corps on Net Worth

When an S Corp is right for you, the transition should have three big benefits for your finances: 

Tax savings: What if you could save thousands every year by making one decision? An S Corp election makes you build out a payroll, cutting out a high percentage of costly self-employment taxes. Plus, with an S Corp, you can maintain legal protection and tax compliance. It’s not just about paying less to the IRS — You’ll also have more cash to put to work elsewhere. 

Long-term financial planning: S Corps and 401(k)s are a perfect pair. With your tax savings from transitioning to an S Corp, you can speed up your time to retirement. Once you know how much you saved in taxes, you can take that money and reinvest it. That cash flow impacts your entire financial life.

There’s lots of options for you to save for retirement by using your S Corp income. Instead of paying it to the IRS, you can put it into a (SEP) IRA or a solo 401(k).   

Fewer year-end surprises: Once you set up payroll, tax payments should be easy and obvious — you can plan right around them, and manage your money year round. 

In addition to saving for the previous year, we use that year’s return as a baseline for the following year. This helps us show how foreseeable changes in our client’s income might impact their taxes and how we can make adjustments proactively. 

For the most part, filing the tax return is the final step. It’s putting a bow on all the hard work and planning we did throughout the year.

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If you think you’re approaching that magic six-figure moment (or whatever threshold makes sense for you), we’re ready to walk you through it. 

S Corps aren't a one-size-fits-all, but for the right business at the right stage, they can be powerful. 

When you understand the financial gains at stake, deciding on an S Corp actually becomes fun — Our advisory team lives for powerful financial moments like these. We work with thousands of clients looking to maximize their financial portfolios and guide them along the path that makes sense for their goals. Get started here — we’ll talk through your business entity and more.