In a previous article, we discussed the benefits of S-corporations for your Maine-based small business. Here we’ll delve further into the idea of S corporation conversion, as the federal self-employment (SE) tax doesn’t apply to earnings from an S corporation business. If you’ve reached the breaking point with high SE taxes, there may be a way to get some relief by converting your existing unincorporated small business into an S corporation.
The FICA tax applies to salary compensation paid to an S corp shareholder-employee.The employee share of the FICA tax is withheld from an S corporation shareholder-employee’s salary; the other portion is paid by the corporation directly to the U.S. Treasury.
The tax-saving point
The FICA tax is only due on an S corporation shareholder-employee’s salary. So when the company pays only a portion of its profits to the owner, or owners, in the form of a reasonable salary, with the remaining portion paid out in the form of cash distributions, only the salary is hit with Social Security and Medicare taxes (in the form of the FICA tax). The profits paid out as cash distributions are exempt from the FICA tax (and exempt from the SE tax too). This can mean significant savings to you as a small business owner. And if your small business maintains its current level of profitability, you will see the same savings year in and year out.
Of course, an S corporation may not be the best option for every small business. There are caveats that you must remember before you make the conversion, such as: increasing your potential for an IRS audit, and possibly less in retirement contributions due to the smaller salary. Also, there are some state law corporation requirements that must be followed, such as holding annual meetings and keeping minutes. An S corp does create some paperwork and other details that must be followed. Consult with Filler & Associates to find out if converting to an S corporation is best for your small business. We can help examine all the necessary facets of the conversion and guide you in the right direction.