John Briggs explains why S-corps save small businesses money on ordinary income. By splitting income into salary and distributions, you avoid the 15.3% self-employment tax on part of your earnings, typically saving about $100 per $1,000 of revenue. Set one up by forming an LLC or corporation with your state, then filing IRS Form 2553.
Why is the S corp one of the best entities for small business, and how do you set one up? I was in a training last week with a mastermind group, and this question came up. So when it comes to the right entity selection, so we're talking about S corps, LLCs, partnerships, corporations, sole proprietors, those are entities. We want to pick the right entity that matches the type of income we're making because the tax code doesn't just say, oh, you made a dollar. They'll say like you made a dollar of ordinary income, or you made a dollar of self-employment income, or you made a dollar of passive income. So if you have a business that sells products or services, That type of income is considered ordinary income, and with it has this fun little tax tied to it called self-employment tax. At the recording of this video, that is a 15.3% self-employment tax. It's called self-employment tax because the employer, which is you, pays 7.65%, And the employee, which is you when you're self-employed, also pays 7.65%, hence the 15.3%. That is a tax rate on top of your income tax. So if I made money and say I'm in the 15% tax bracket, but that's self-employment income and I have the wrong tax structure, I could easily be paying 30% tax instead of 15% tax. The S corp is a great entity that helps us reduce that self-employment tax. It doesn't get you out of all of it. We have a lot of blogs that go into a lot more detail when it comes to how that 15% works, and when you have an S corp, what are some of the compliance things that you need to do to make sure that you don't get in trouble with the IRS. But, for the sake of answering the question, why is the S corp one of the best entities? If you are earning ordinary income, so if you have a business that sells products or services, that is ordinary income, the S corp will help you reduce the self-employment tax portion. Simple math, this doesn't always work, this is a general statement. For every $1,000 you make in an S corporation, you're going to save about $100 in self-employment tax, okay? Again, it's a general statement. It might not be the exact number for you, but there is a tax savings that happens. When it goes to the question of how do I set one up, this is where it gets fun because no state will allow you to set up an S corporation. Why? Because the S corporation is a tax status only. So that means, as far as the IRS is concerned, yes, there's S corps. With the state, you're going to set up an LLC or you're going to set up a corporation with an Inc. at the end of the name. So you have to set up the entity with the state, and then if you set up an LLC or you set up a corporation, whichever one you do, You then fill out a form with the IRS, it's Form 2553, it's 2 pages, well it's 3, but you only fill out the 2 pages, and you send those 2 pages to the IRS that says, hey, I have this entity that I set up over here with this state, please treat it like an S corporation. So it's really easy, the Form 2553 is only going to ask you for information about your business and information about you. Which is very easy to have, it's not complicated, but you send that off, that's how you set up an S corporation. So, in summary, if you're earning ordinary income, you want to consider if an S corporation makes sense in your tax structure. By setting up the right entity, you will reduce unnecessary taxes. Remember, profit is a choice, have the courage and wisdom to choose it.
