Confused owner of a an S-Corp

August 18, 2016 7:07 PM

2016 is the first year that my LLC will elect to be taxed as an S Corp. I'm confused about how this works and my CPA has disappeared, and I'm about to move out of state and want to understand this process more when I hire a new one. Can you give me a better sense about how I should estimate my taxes on distributions so I can save properly?

Please forgive me if my explanation contains misinformation or miswording, as this process has been confusing to me. I've spent hours trying to figure this out and I understand that a CPA will help and will be hiring one, but it would be helpful if I could hold off on that until closer to tax time and be sure I'm saving properly for taxes in the meantime. Talking to my now MIA CPA made me feel stupid and I often didn't even know how to phrase my questions. I want to be better prepared! You are not my accountant, you are not giving me tax advice, etc.

For the past few years, I've been self-employed as a graphic designer, and this is the first year that my business LLC will elect to file as an S Corp. I'll bring in around $90,000 this year, and I'm paying myself a yearly salary of 60% of that ($36,000) with a payroll service. I have no other employees other than myself. This part makes sense to me and I love having the taxes taken out each month without much work on my part.

It's planning for the taxes on the remaining $36,000 that I don't understand. The explanations for how it's taxed really confuses me — I keep reading the same words over and over, and they don't compute. All I want to know is: roughly, what percentage should I expect to pay to Uncle Sam on that amount? How is that calculated? The worksheets I've been referred to confuse the shit out of me! I won't be preparing my own tax return, I just want to make sure I'm setting aside enough money for taxes and I want a better understanding of the terms involved.

I have very few business expenses this year, so for the sake of keeping answers simple for my sake, let's pretend I have none.

Please be gentle. Writing this question made me tear up — I hate feeling stupid.

posted by the thorn bushes have roses to Work & Money (13 answers total)

An S corp's income passes through to its shareholders for tax purposes in proportion to their share of ownership. Its expenses also pass through. One of the Turbotax editions can handle S Corp stuff.
posted by zippy at 7:10 PM on August 18, 2016

I have an s-corp in this same basic circumstance. Here's how the taxes work for me.

On your salary, you're paying state income, federal income, Social Security, and FICA. Under normal circumstances, as an employee, you'd only worry about the income and Social Security taxes. The FICA tax is the employer's side. If you're using Gusto/ZenPayroll (which I recommend) they will handle this for you. Other payroll services likely handle it as well but I can't speak for them.

The rest of the money is considered a direct distribution and you only pay income tax on it.

In your circumstances, you should be looking into the self-directed retirement accounts. Personally, I was able to create a situation with a SEP IRA where I ended up owing no income taxes on my direct distributions.

Edit: to be clear, I'm not an accountant either, but I have set all this up. This info may not be 100% precise in terminology.
posted by feloniousmonk at 7:12 PM on August 18, 2016 [1 favorite]

So, let's say Alice owns 100% of an S Corp and that Corp has $30k in income and no expenses (but there are always expenses, and you'll want these). That means Alice pays taxes on (whatever she earned normally) plus $30k.

Now for corporate expenses, these lower Alice's taxes. Company paid a $30k salary to someone? That's an expense. Even if it was salary for Alice. In that case Alice has no net S Corp taxes but now has $30k in taxable regular income.
posted by zippy at 7:14 PM on August 18, 2016

Best answer: You're making this probably too complicated and it is, but generally you're going to probably pay around 30% in taxes in the amount you have earned outside of the payroll.

In essence the payroll ends up as an expense so your income is 90k-36k = 54k so I'd guess your tax bill will be around 15-16k.

We keep around 40% of our earnings (profits) earmarked for taxes and take the excess as distributions once we actually pay our taxes. (note we actually keep 20% of all revenue in savings for taxes, this ends up being around 40% of income)
posted by bitdamaged at 7:17 PM on August 18, 2016

Running your numbers: $90k s Corp revenue, $54k (your 60% take) paid to you as income, leaving your company with a profit of $36k, you pay income tax on ... $90k. In your scenario, no matter what you pay yourself, it's all going to add up to $90k (ignoring FICA, social security).

So plan on income taxes on around $90k

You can bring this number down by listing (itemizing) your business's expenses. Bought Quickbooks? Business expense. Paid someone to set up a website? Expense. Incorporation fees? Expense. Tax prep fee? Expense.
posted by zippy at 7:20 PM on August 18, 2016

Best answer: (Your post has 36k in two spots)

Sorry quick correction if your payroll is 54k then you pay taxes on 36k which puts your tax bill at about 10-11k
posted by bitdamaged at 7:24 PM on August 18, 2016

Response by poster: Thank you, bitdamaged! That's helpful and gets to my question, what percentage I should expect to be taxed on outside of payroll (distributions). And yes, sorry, 54K is what I pay myself via payroll, 36K is the leftover.

Please note: I have payroll covered. Please god, don't advise me on that, it's one of the things I DO have handled! I also understand the advantages of an S-corp and how deductions work to reduce my tax bill. Maybe I made myself sound a little too clueless, though I will admit that a lot of this is over my head, thus, AskMefi :-) I don't need advice on payroll, how to maximize deductions, filing tax returns, etc; my need lies in being able to roughly estimate what to save for taxes so I'm not blindsided and being able to feel more confident when I meet with a new accountant.

Zippy, I'm not sure I understand your second answer. I understand that I'm going to pay taxes on the full 90K other than deductions, but I don't understand the rate at which the distributions are taxed. Through payroll, I can see what I'll be paying in taxes on 54K and plan for that. Are you saying I could just roughly estimate my taxes as if I were any regular W2 employee making 90K?
posted by the thorn bushes have roses at 7:41 PM on August 18, 2016

Best answer: I think Zippy is saying you pay taxes on the 90k (Assuming thats profit after expenses). Which is totally true. My assumption is that the taxes for the 54k in salary is taken out in payroll as if you were just an employee so the taxes on that amount is already "paid" and you only have to pay on the income outside of the payroll.

This assumes that you (just like any normal salaried employee) has declared the right withholding such that the taxes taken out will cover your tax bill on the salary you're paid - noting too that if you have excess being withheld it will reduce your tax bill on the 36k .
posted by bitdamaged at 8:07 PM on August 18, 2016

Best answer: The simple answer, as zippy pointed out, is that your taxable income is $90K. An S-corp is known as a "pass-through" entity. All income, whether as payroll or as dividends passes through to you as taxable income. So it is taxed at the same rate as all your other income. The only thing you save is FICA taxes on the dividend portion.

My question would be who talked you into forming an S-corp? Your CPA? because he probably increased his fee income by complicating your business. An S-corp might save you a few thousand dollars of FICA taxes but it might also be costing you a few thousand dollars in other expenses -- LLC fees, CPA fees and payroll service fees such that it is nearly a wash, not to speak of the extra hours of your time wasted to manage all this and the tears that led to this question.

In addition, by reducing your payroll income you will be lowering your Social Security contributions so that you will receive lower benefits at retirement. And finally, you are reducing the amount of money you can put away into tax deferred retirement accounts, because the maximum you can save is a function of your payroll income, not your dividends. You might actually have lower taxes by taking all your income as salary and not as dividends.
posted by JackFlash at 11:25 PM on August 18, 2016

Response by poster: Jack Flash: your first paragraph helps, thanks.

The cost of the S-Corp election is far less than my tax savings. I am not asking if it's right for me. If anyone has any further answers, I would be eternally grateful not to see another definition of an S-Corp—my googling has led me to see that more times than you'd believe!
posted by the thorn bushes have roses at 1:59 AM on August 19, 2016

I hate to be the bearer of (potentially) bad news, but even if you set aside money to pay the taxes for the approximately $36K of profit in your S-Corp, you may still get dinged with a penalty for not having withheld enough. It's hard to say for sure without knowing the rest of your tax situation, but you may need to be making quarterly estimated tax payments so that at the end of the year you have withheld at least 90% of your ultimate tax liability. (The only way to get out of the penalty for withholding too little is if you withheld an amount equal to or greater than your prior year's tax liability.)

If you have lots of capital gains and dividends paying out (even if these are reinvested) through the year, you will almost certainly need to make estimated tax payments quarterly. If cap gains and dividends don't contribute much to your taxable income at the end of the year, you can probably avoid the whole 1040-ES issue by withholding more from your paychecks. Contrary to common belief, the withholding tables are only suggestions. You can always withhold more and, as the only employee (AKA chief cook and bottle-washer) it's pretty easy to set the withholding for Federal (and state, if relevant) taxes at whatever amount you determine will leave you in the best shape at the end of the year.
posted by DrGail at 5:22 AM on August 19, 2016

The cost of the S-Corp election is far less than my tax savings.

How can you know that if you are here asking how much you owe in taxes.
posted by JackFlash at 7:50 AM on August 19, 2016

Response by poster: I do make quarterly estimated payments equal to 100% of what I paid last year.

Considering this case closed, as bitdamaged pointed out, I have been way overthinking this! Thanks!
posted by the thorn bushes have roses at 8:26 AM on August 19, 2016