The structure of your business dictates how it's taxed. If you just start a business without forming a corporation, the profits will flow directly to you, and you will pay both self-employment and income tax on the money. However, if you form an S-corp, you can reduce your self-employment tax bill. For forming corporations, here's what you need to know.
1. Self-employment tax is 15.3 percent
As of 2022, the self-employment tax is 15.3 percent. This consists of Medicare and Social Security. Normally, when you have a job, you pay half this amount, and your employer pays the other half. When you're self-employed, you pay both halves, and that can add up fast.
2. S corps pay income tax on top of self-employment tax.
When you file your tax return, your business profits will be subject to both self-employment and income tax. Your income tax rate will vary based on your income. As of 2022, the income tax rate ranges from 0 to 37 percent.
3. S-corps pay owners a salary.
If you opt to have your business taxed as an S-corp, your business will pay you a salary. In contrast, if you run a sole proprietorship, all of your profits make up your income. To be on the safe side, you need to choose a salary that makes sense for your industry.
The amount you select as your salary will be subject to self-employment tax. You will pay the same rate noted above.
But technically, you personally will pay your half, and the S-corp will pay the other half. This is just like how your employer pays half when you have a traditional job. But in this case, you are both yourself and your employer.
4. The remaining profits face income tax.
The remaining profits from your S-corp flow to you. As a result, you pay income tax on them, but you avoid the self-employment tax. This can help you save a lot of money.
5. S-corps can have up to 100 shareholders.
You don't have to run an S-corp on your own. You can have up to 100 shareholders. Some of the shareholders may also have salaried positions in the company. Some of them may just own shares. All of the shareholders split the profits and report them on their tax returns. If you want more than 100 shareholders, you have to form a C-corp instead of an S-corp.
To get more help and to decide if this is the right business structure for you, contact a business formation specialist.