Small Business Owners Can Still Save Thousands in Employment Taxes, But Door is Closing

Small business owners can still shelter a significant portion of their income from taxes through use of a Sub S Corporation tax break, but this option may not last forever. Recently, the Senate refused to budge and allow the death of the substantial tax break currently given to S Corporations that allows business owners to avoid paying payroll taxes on their profits.

S Corporation owners can take advantage of this tax break by paying themselves as little as possible–a “reasonable” salary taxed as regular income–and distributing the remaining profits as distributions, thereby avoiding an additional 15.3% tax.

As we reported earlier this year, it did seem likely that Congress would pass a bill to eliminate this tax break to raise revenue. But this portion of the bill is now on hold because of stiff Senate opposition.

Small business owners should review their current pay structure to be sure they are aware of this Sub S tax break. Currently, small business owners who convert to Subchapter S status can treat what is essentially a salary as dividend income, avoiding both higher tax brackets and a combined 15.3% in Social Security and Medicare taxes.

For example, if your Subchapter S business shows a net income of $125,000 and you pay yourself a salary of $100,000, you will pay $15,300 in payroll taxes (Social Security and Medicare). Half of the payroll taxes will be withheld, leaving $92,350 as salary. The other half will be paid from the remaining profits of your corporation, leaving $17,350 profits to be distributed. Thus, paying yourself this way leaves you with a total of $109,700, in-pocket.

If instead you cut your salary to $60,000 (following proper corporate procedures), you and your S corporation pay a combined $9,180 in payroll taxes, and the remaining corporate income is distributed to you without the payroll taxes. You’ll pocket $115,8200, saving $6,120.

Although this will result in a slightly higher income tax, the savings more than make up for this increase.

Of course, paying a smaller salary means you pay smaller amounts into your Social Security account–but you may already have sufficient pay-ins to qualify for benefits.

In this economy, small business owners should re-evaluate their current tax strategy to take advantage of every tax favored option available to them.