Your Definitive Guide on the Differences Between Sole Proprietorships and S-Corporations
This month, I’m offering clarification on a subject briefly touched on in my previous post.
THE PROFIT TO PROSPERITY MEMBERSHIP CONTAINS LASTING AND PRACTICAL VALUE
And that subject is not the lasting and practical value of the Profit to Prosperity Membership--no clarification needed there.
As I said before, regarding that subject, with a monthly valuation of $975 vs. an actual monthly investment of $97, Profit to Prosperity members are looking at $878 of monthly savings. Plus, 95% of business owners with whom I’ve worked have seen a direct net profit increase within the first year of our partnership, so your membership will likely pay for itself. And besides all that, you can actually write off your membership expense. So there’s truly no reason not to become a Profit to Prosperity member!
No, we’re all good there.
WHAT YOU NEED TO KNOW ABOUT BUSINESS TAX CLASSIFICATION
The subject on which I want to park today is that of tax classification.
Last time we talked taxes, we brushed through this while discussing FICA taxes--how when you’re traditionally employed, meaning you’re paid wages by a business in exchange for your time, you only pay half of the 15.3% FICA tax for which every citizen is liable, so roughly 7.65%, and your employer pays the other half. Whereas when you’re self-employed, you yourself are both the employee and the employer. So you pay both halves; you’re liable for the entire 15.3% FICA tax.
TAXES FOR BUSINESSES CLASSIFIED AS SOLE PROPRIETORSHIPS
But that’s assuming your business is classified as a sole proprietorship. And if it’s in its early years and/or you don’t share ownership of your business with anyone, it’s likely to be classified as a sole proprietorship.
TAXES FOR BUSINESSES CLASSIFIED AS S-CORPORATIONS
But there’s an entirely other business classification that opens up a whole new can of taxation worms, which is that of the S-Corporation.
THE DIFFERENCES BETWEEN SOLE PROPRIETORSHIPS AND S-CORPORATIONS
There are a few major differences between sole proprietorships and S-Corps, including:
How the business is viewed from a tax perspective:
In a sole proprietorship, your business and you as its owner are considered one in the same. The business’ income is your income. For this reason, your business income and expenses get included on your personal income tax return (Form 1040) on Schedule C.
In an S-Corp, however, your business and you as its owner are considered separate entities. So you have to file a separate tax return for your business (Form 1120S) in addition to your individual tax return (Form 1040).
How you get paid as the business owner:
If your business is classified as a sole proprietorship, getting paid is super simple. You just transfer cash from your business bank account to your personal bank account in a process known as ‘making a distribution’.
As an S-Corp, however, your business actually pays you an annual salary, which typically gets processed through a digital payroll system. So the whole thing is a little less simple, but a little more like what you might be used to if you were originally traditionally employed.
How your business gets taxed:
As a sole proprietorship, your business’ net profit is subject to a variety of taxes--to the income tax rate because, as I said before, from the perspective of the IRS, your business’ income is your personal income. And subject to the 15.3% FICA tax, which includes Social Security and Medicare paid from both the perspective of the employer and the employee.
As the owner of an S-Corp, however, your tax liability is broken down a little differently.
Your business’ net profit is still subject to the income tax rate (remember that net profit = total revenue - business expenses). And there will be a few more expenses on your Profit and Loss Statement, as an S-Corp, than there were as a sole proprietorship, namely your salary. Plus the payroll tax, implementation of a payroll system, and fees for additional professional tax services. So, that means what’s left to tax will be less than before.
On the other hand, in the case of your personal tax liability, your salary is subject to the income tax rate and FICA tax. So, you guessed it--you’re also paying FICA taxes on a smaller amount of money.
As you can likely imagine, there are some strategic tax savings opportunities here.
WHEN TO ALTER YOUR TAX CLASSIFICATION TO BECOME AN S-CORPORATION
I, and several other finance professionals that I trust, are of the mind that when businesses’ net profits cap $50k annually, their owners should consult their tax professionals regarding whether to consider altering your tax classification to become an S-Corp.
At that level of annual income, your increased revenue should off-set the additional expenses of the payroll tax, implementation of a payroll system, and fees for additional professional tax services that come with reclassification as a S-Corp, but it’ll take detailed analysis to know for sure.
And that’s, of course, where the value of your tax professional comes in. Click HERE to learn about how to know whether you’ve found the right one--it’s important.
ANOTHER REASON WHY THE PROFIT TO PROSPERITY MEMBERSHIP IS SO VALUABLE
What you’ve learned today demonstrates the layered value of the Profit to Prosperity Membership.
With direct access to me, an experienced virtual CFO, plus connection to a strong community of fellow female entrepreneurs, you’ll gain the business financial management skills you need for:
Increasing your business’ net profit to cap $50k annually
Knowing what to do when you get there so you don’t get taken for a ride by the IRS
Feeling confident about who you’ve hired to help manage your business’ tax strategy so you know you’re getting all the benefits of savvy business, while also staying in the clear legally
It’s time for you to take the plunge. Click HERE to read more about and to join the Profit to Prosperity Membership!
And, of course, always feel welcome to reach out with questions.
- Stevie
