We are beginning a blog series on five tax loopholes to consider using before it’s too late. These strategies are worthwhile to keep in mind throughout the year and specifically at year-end.  

The first tax loophole and tax planning tool to learn about is the retroactive S Corporation (S Corp) election. An effective tax planning tool for sole proprietors and partnerships, this election can be made at any time during the year for an effective date of January 1. 

What is an S Corp? 

S corporations are corporations that elect to pass corporate income, losses, deductions and credits through to their shareholders for federal tax purposes. To become an S Corp, the owner must file Form 2553 with the Internal Revenue Service (IRS). 

Benefits to Retroactive S Corp Election 

Avoiding double taxation. When business owners decide to set up their business structures as Limited Liability Corporations (LLCs) or as Schedule Cs, they must report business income on their personal tax returns. Income coming through those businesses to the business owner personally is essentially considered self-employment income. 

By passing income and losses through to shareholders and reporting the flow-through on their personal tax returns, S Corp owners pay taxes at their individual income tax rates and avoid double taxation on corporate income. 

Reducing tax liabilities. A business owner should expect reasonable income for someone working in that executive role. However, payroll taxes on a business owner’s salary can create a significant tax burden when the business’s income is treated as self-employment income. 

Self-employment income is taxed at 15.3%, which includes the employer’s contribution, the employee’s contribution, Social Security, Medicare and unemployment tax. Above that, ordinary income tax must be paid. While the official ratio of ordinary income to payroll is often debated, generally business owners are looking at 20%-30% of total income being considered payroll. 

The S Corp election is an effective tax planning tool for sole proprietors and partnerships because it avoids self-employment tax on a substantial portion of the business owner’s income. Taking an S Corp election allows business owners to split their income and earnings between payroll and ordinary income. Ordinary income is not subject to self-employment taxes because the income of an S Corp is generally taxed to the shareholders of the corporation rather than to the corporation itself.  

In short, an S Corp is relatively inexpensive to arrange, but it can save you thousands in taxes. 

S.J. Gorowitz Tax and Accounting Services can help you take advantage of this tax loophole before it’s too late; however, it’s never truly, “too late.” You can always start tax planning for next year. Please contact us at 770.740.0797 or email info2@SJGorowitz.com.