Nobody likes to think about or pay taxes, but when you own a small business, you can’t avoid it. Instead, you can try and minimize their impact on your business. If you are a sole proprietor or a partnership, there isn’t much you can do to reduce taxes; you just need to make sure you account for your legitimate business expenses. However, if your company or corporation is a limited liability, there might be a couple of things you can do to reduce taxes.
Disclaimer: The following are general principles. You should consult with your accountant and lawyer to make sure you correctly apply these principles to your specific situation.
Elect to be taxed on an S-corp basis.
S-corp is a Federal tax status. Originally, it allowed the owners of a corporation to be taxed on a partnership basis. Now, because of check-the-box rules, a limited liability company can elect to be taxed as an S-corp. This makes sense for a small business that makes a profit and can afford to pay the owner a salary. The benefit is if the owner is taxed as a sole proprietor, the owner pays FICA on the entire amount. However, if you elect to be taxed as an S-corp and are paid salary, you only pay FICA on the salary.
For example, let’s say your business nets $150,000. A reasonable salary for you might be $50,000. You pay FICA on the $50,000, but not on the $100,000 profit, a savings of approximately $15,000 in taxes.
Please note, that if a company does not make a profit, there is no benefit to select the S-corp status. Also, be aware that when you convert your company to an S-corp, you might need to go through some hoops to keep your bank happy.
Elect to be taxed as a C-corp.
This check-the-box option applies if your company is either a limited liability company or a corporation. This is not something a small business normally does, but you might consider it if your business plan is company growth and you want to use business profits to expand your business. In this case, your corporate tax rate might be less than your individual tax rate, so it is better to leave the money in the corporation. Opposed to the S-corp status in which income flows directly to the owners, a C-corp entity will only have to pay taxes on the dividends paid to you (and of course any salary you receive), not on the company profits.
As is normal with any legal or financial advice, here is the disclaimer. These are general principles. You should consult with your own accountant and lawyer to make sure how to apply these principles to your specific situation. Also, make sure that you consult with your professionals before taking action. I had a client that was told by an accountant that he needed to be an S-corp, so he formed a corporation and elected to be taxed as an S-corp. Unfortunately, he did not do some of the other things that he should have been doing and ran into an issue with Idaho Industrial Board. We resolved the issue, but if he had done what he should have from the beginning, he wouldn’t have had to pay me to solve the problem.
Mark Peters has been attorney for over 30 years. Mark is the owner of Peters Law, PLLC in Boise, Idaho specializing in Business law, including formation, organization, employment and contract issues; Licensing; Family law; Guardianship and Conservatorships; Civil litigation; Probates; Wills, Trusts and Estate Planning. He has negotiated and documented just about any type of transaction that can be imagined: supply agreements, real estate, intellectual property licenses, and trademark licenses.