Even though the agony of filing your income taxes is done for 2015, you might still be feeling the pain if your tax liability put a hurting on your bank account.
And you might be wondering how to avoid a hit like that in the future.
Maybe It’s Time To Change Your Business Legal Structure
If you’re self-employed and operating as a sole proprietor, I suggest exploring if a change in legal structure might provide some tax relief for your business.
Sole proprietors can rack up an exceptionally hefty tax bill because they’re required to pay self-employment (Social Security/Medicare) taxes in addition to their federal, state, and local income taxes. By transitioning to an S Corporation status, you might reduce your self-employment taxes. When operating as an S Corporation, you’re allowed to split your profits into two distinct payment types:
- Your salary
- S Corp distributions.
You pay the 15.3 percent Social Security/Medicare tax only on the salary portion of your revenue.
So, if your company made $100,000 in profit and you paid yourself $50,000 in salary and the other $50,000 in distributions, the 15.3 percent self-employment tax would apply to only the first $50,000.
Pretty sweet, right?
But don’t get carried away and think you can pay yourself something ridiculous like $5,000 in salary and $95,000 in distribution. The IRS pays attention and will take notice if any shareholder who is employed by the business isn’t receiving a “reasonable compensation” as their salary. Be sure you’re paying yourself the market rate for services you provide to your S Corporation—it’s far better to do it right from the start than to have to explain yourself and risk repercussions later.
When’s The Best Time To Make The Change?
The tax benefits you might receive by changing your business structure will begin upon the date you incorporated. They are not applied retroactively, so the earlier in the year you change your structure the more of your business income will be subject to the advantages. For instance, if your corporation receives a filing date of May 1, 2016, you’ll still need to file your taxes as a sole proprietor from January 1 up until that date. From May 1 through December 31, 2016, you’ll file your taxes as a corporation for the remainder of the year.
Beyond The Tax Benefits
Besides the potential tax benefits, changing from a sole proprietorship to an S Corp (or LLC or C Corp) also helps protect your personal assets because your business becomes a separate legal entity. This means your company (and not you personally) is responsible for all of its liabilities and debts.
Is A Change In Legal Structure Right For You?
Every business has its own unique financial situation, so there’s no definitive answer whether a change in legal structure will benefit you. To make sure you’re making an informed, educated decision, I recommend consulting with a tax advisor or CPA to discuss your specific circumstances.
Have you already made the decision to change your business legal structure? Give us call call today for a free business consultation and we can help get the process started for you! 888.449.2638
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