As a small business owner or entrepreneur under 50, keeping more of what you earn is key to building long-term financial security. One of the smartest strategies for reducing your tax burden is electing to have your business taxed as an S-Corporation (S-Corp). But how exactly does this work, and what steps can you take to maximize the benefits?
In this post, we’ll explore the ins and outs of the S-Corp election, how to lower your tax bill through salary and distributions, and how you can pair an S-Corp with a Solo 401(k) for even greater tax advantages.
What is an S-Corporation?
An S-Corporation (S-Corp) is not a type of business entity, but a tax designation you can elect if your business is structured as an LLC or corporation. The key advantage of choosing to be taxed as an S-Corp is the way it handles self-employment taxes. You can split your income between salary and distributions, reducing the taxes you pay on your business profits—especially as your business grows.
How Does an S-Corp Save You Money?
Salary vs. Distributions: The Core Tax Strategy
With an S-Corp, you have the flexibility to pay yourself a salary for the work you do and take the remaining business profits as distributions. Each of these is taxed differently:
Salary: This is subject to payroll taxes, which include:
FICA taxes (Social Security and Medicare): A total of 15.3% is split between employer and employee.
Social Security Tax (12.4%): You’ll pay Social Security tax on your salary up to the wage cap, which is $168,600 in 2024. Once your salary exceeds this amount, you no longer pay Social Security tax on earnings above this threshold.
Medicare Tax (2.9%): Medicare taxes have no cap, so you’ll continue paying this tax on all of your salary, no matter how high it goes.
Additional Medicare Tax (0.9%): If your earnings exceed $200,000 ($250,000 for married couples filing jointly), you’ll also pay an additional 0.9% on income above these limits, thanks to the Affordable Care Act (ACA).
Distributions: The remaining business profits you take as distributions are not subject to FICA taxes. This means you’ll pay income tax on them, but you avoid the 15.3% self-employment tax that applies to salary. This can lead to significant tax savings, especially as your business grows.
Example: S-Corp Tax Savings in Action
Imagine your business brings in $150,000 in net profits for the year. With an S-Corp, you could pay yourself a $50,000 salary and take the remaining $100,000 as distributions.
You’ll pay FICA taxes on your salary (about $7,650).
The $100,000 distribution is only subject to income tax—not Social Security or Medicare taxes—resulting in potential payroll tax savings of around $15,300.
This simple split between salary and distributions can dramatically reduce your overall tax liability while keeping your compensation structure compliant with IRS rules.
Understanding FICA Taxes: When Social Security Caps Out
One of the key reasons S-Corps are so effective at reducing taxes is how they interact with FICA taxes. Here’s what you need to know:
Social Security Tax: As of 2024, Social Security tax applies to wages up to $168,600. This means you pay 6.2% (employer-side) and 6.2% (employee-side) on your salary up to this threshold. Once your salary exceeds $168,600, you no longer pay Social Security taxes on any income above that amount.
Medicare Tax: Unlike Social Security, Medicare tax has no cap. You’ll continue paying 1.45% (employer-side) and 1.45% (employee-side) on your entire salary, regardless of how high it goes. For higher earners, an additional 0.9% surtax kicks in for income exceeding $200,000 for single filers or $250,000 for joint filers.
Understanding how these caps work is critical for maximizing your tax savings with an S-Corp.
Boosting Your Savings with an S-Corp + Solo 401(k)
For young entrepreneurs and small business owners, pairing your S-Corp with a Solo 401(k) can unlock even more tax benefits. Here’s how:
Salary Deferral: As an S-Corp owner, you can contribute up to $23,000 of your salary ($30,500 if you’re over 50) to a Solo 401(k), reducing your taxable income.
Employer Contributions: Your business can contribute up to 25% of your salary toward your Solo 401(k). In our earlier example, with a salary of $50,000, the business can contribute an additional $12,500, for a total contribution of $35,500 in retirement savings for the year.
These contributions reduce your taxable income in the short term and help build long-term financial security through retirement savings. Combining an S-Corp with a Solo 401(k) is a powerful way to minimize taxes while setting yourself up for the future.
Don’t Forget Health Insurance Deductions
As an S-Corp owner, you may also be able to deduct the cost of health insurance premiums for yourself and your family. These premiums will be reported as part of your W-2 salary, which means they’re subject to income tax but not subject to payroll taxes like FICA. This deduction is another way to reduce your overall tax burden, even though it adds to your taxable wages.
Administrative Considerations for S-Corp Election
While the tax savings from an S-Corp can be substantial, there are a few administrative requirements to keep in mind:
You’ll need to file Form 1120S for your S-Corp each year.
You’ll need to run payroll and ensure quarterly payroll taxes are filed.
It’s important to keep accurate records of your salary and distributions to avoid any IRS issues.
The extra paperwork and accounting can be worth it for the tax savings, but it’s always wise to consult with a CPA or tax professional to make sure your business is compliant and maximizing its tax benefits.
Is an S-Corp Right for You?
For many young business owners, electing S-Corp status makes sense once your business is consistently earning over $50,000 annually. If you’re paying yourself a modest salary and still have substantial profits left over, switching to an S-Corp can save you thousands in taxes each year. It's best to speak with a financial professional prior to making this election so you can guarantee the tax savings outweigh the administrative costs.
Conclusion
Maximizing your tax savings with an S-Corp can be a game-changer for young entrepreneurs. By taking advantage of salary and distributions, understanding FICA taxes, and combining S-Corp status with a Solo 401(k), you can reduce your current tax burden and build wealth for the future.
If you’re not sure whether electing S-Corp status is right for your business, consult with a financial advisor or tax professional to get personalized advice based on your situation.
Need help navigating tax strategies for your business?
At WealthBound, we provide a free analysis of your current entity structure and make recommendations around which structure will benefit you the most. Reach out today if you want to make sure you're not overpaying on taxes.