Client A, an active stock trader in Massachusetts, was on track to pay $634,000 a year in taxes. After an S-Corporation election, Solo 401k, and PTET election, we dropped the total taxes to $491,440. That is a tax savings of $142,674 a year!
Client B, a medical practice owner in Illinois, was paying $291,405 in taxes a year. After an S-Corporation election and Solo 401k, that lowered the taxes to $201,206, a tax savings of $90,199 a year!
These are real clients. Real tax plans. Real numbers.
The S-Corporation election is one of the most powerful tools in tax planning. Whether you run a consulting firm, a medical practice, or a service business, the structure works the same way.
But. It’s not for everyone. There is a lot of misguided information out there about when it works, who it’s for, and what it actually saves. Most of it is oversimplified.
In this article, we’re going to show you exactly how that math works and whether it applies to you.
What is an S-Corporation (The Plain English Version)
What is an S-Corporation?
An S-Corporation is a business structure where profits pass directly to the owner's personal tax return, avoiding the double taxation of a C-Corporation. Owners can split income between a salary and distributions, with only the salary subject to Social Security and Medicare taxes (FICA — 15.3%). This split is the core of how an S-Corp saves taxes.
Before we dive deep into the tax savings of an S-Corporation, let’s take a step back and quickly discuss the basics.
An S-Corporation is a tax election, not a business entity. Most business owners elect S-Corporation status through their existing LLC or C-Corporation by filing Form 2553 with the IRS.
At the basic level, an S-Corporation is a pass-through entity. That means profits and losses will pass through the company and onto your personal return where they will be taxed at your personal income tax rate.
At the Federal level, most S-Corporations will pay no tax directly, but that tax will be reflected on your personal return. At the state level it could be a mix of the two. Some states have corporate or franchise taxes that will be paid by the corporation but most income will flow to the personal return.
There will be limited liability protection with an S-Corporation as only corporate assets are at risk. Any shareholder losses are limited to investment in the stock of the company, and not their personal assets.
Even though a S-Corporation seems simple enough, it is not for everyone. You can actually pay more in taxes with an S-Corporation if you don’t set it up properly.
Why S-Corporations Save Money on Taxes
How does any S-Corporation save on tax?
In a sole proprietorship or LLC, all business profit is subject to 15.3% self-employment tax. With an S-Corporation, you split that income into a salary, which is subject to self-employment tax, and distributions, which are not. By paying yourself a reasonable but efficient salary, you reduce the amount of income subject to payroll taxes and keep more of your profit.
With a sole proprietorship or an LLC, all business profit is subject to 15.3% self-employment tax. This is also known as FICA taxes or your Social Security and Medicare tax. If you ever went to file your tax return and noticed you suddenly had a huge tax bill, this was the cause of it.
When you are not the business owner and work for an employer, normally the employer pays half (7.65%) and you pay half (7.65%), which is reflected on your paystub. When you become the business owner, you are now on the hook for both halves of those taxes, and they can really add up quick!
If you had $175,000 in business profit, you are looking at an additional self-employment tax of $26,775. That is just the additional tax on top of your ordinary income tax rate. It can be tough to be a business owner when you are overpaying in taxes.
we are keeping calculations simple here to illustrate our point
As an S-Corporation you are now given the ability to split your business profit into salary and distributions.
The salary portion will still be subject to the 15.3% FICA taxes. There is no escaping those. However, the distributions are not.
If we take that same example of $175,000 in business profit but now elect S-Corporation status with a $100,000 salary we save $11,475 in taxes every year!
Powerful stuff.
The S-Corporation doesn’t eliminate FICA, it limits it to your salary which is why the salary amount matters enormously in deciding if this is the right tax planning strategy for you. We will talk about salary in detail in a bit.
Now, before you start filling out Form 2553 to elect S-Corporation status, let’s throw a wrinkle into the mix.
Before 2017, everyone was electing S-Corporation status. It is just what you did to save taxes, it worked for everyone! You couldn’t get enough accountants telling you to elect into it to save thousands in taxes.
After 2017, we were introduced to the QBI (§199a), Qualified Business Income, deduction and it took the S-Corporation strategy and turned it on its head.
The QBI deduction was born from the Tax Cuts and Job Act (TCJA) for the sole purpose of leveling the playing field between self-employed individuals and C-Corporations. It gave self-employed individuals an extra 20% deduction on business income. This was a huge tax benefit. As of 2025, the One Big Beautiful Bill Act (OB3), made the QBI deduction a permanent fixture in our tax code, meaning this planning consideration is here to stay.
Why does the QBI deduction matter to S-Corporations and how did it ruin a perfectly good tax strategy?
The QBI deduction is a deduction based on net income of the business. In our earlier example, the $175,000 net profit would get a QBI deduction of $35,000. One key fact to keep in mind, this is not a tax reduction, it is an income reduction, it lowers your overall income so you pay less tax on that income but it is not a one-to-one tax reduction.
Let’s illustrate that last line by saying your effective tax rate is 18%. On $175,000 in self-employment income, you are paying $26,775 in self-employment tax and ((175,000 – 35,000) * 18%) $25,200 in ordinary income tax for a total tax bill of $51,975. That is a lot of tax.
So how does this affect S-Corporations?
When we split our profit between salary and distributions, the QBI deduction only reduces the distributions.
Let’s continue our S-Corporation example, net profit was still $175,000 but this time we reduced that with a salary of $100,000. The $100,000 salary still pays our FICA taxes of $15,300. Now our QBI reduction is only based on the $75,000 net income (distributions), so only a $15,000 reduction of income.
With an effective tax rate of 18% our total tax bill is $44,100. That is made up of $28,800 in ordinary income tax plus the $15,300 in self-employment tax.
Comparing our two examples, we still saved a whopping $7,875 in taxes a year, but it is a bit further than the amazing savings of $11,475 we originally calculated.
Let’s push this example a bit further. What if, everything being equal, we changed the salary from $100,000 to $135,000, what is our tax savings?
Total self-employment tax stays the same: $51,975.
S-Corporation tax: $50,715.
Now you can see how we reached a break-even in our S-Corporation tax strategy by only changing the reasonable compensation we must pay ourselves. If we continued to go higher in salary, we could begin to cost ourselves more in taxes with this strategy versus if we didn’t elect S-Corporation status. This is exactly why getting the salary right is not just a compliance issue, it is the difference between a strategy that saves you money and one that costs you money.
QBI gives us the answer to why S-Corporations are not slam dunk strategies for all business owners. You have to be mindful of all the different tax aspects at play when deciding if this strategy is right for you.
BUST THE MYTH: There is No Magic Income Threshold
At what net profit should I convert to an S-Corporation?
There's no universal income threshold. The benefit depends on your net profit, your state tax treatment, whether you have health insurance premiums, your retirement savings goals, and what salary benchmarks apply to your role. What makes an S-Corp worth it for one business owner may not apply to another. A personalized tax plan is the only way to know for sure.
The most common piece of S-Corporation advice you will hear is also the least useful: elect S-Corporation status after your net profit has hit $XXX. Fill in the blank, we’ve all heard the numbers, $60,000 in profit, $80,000, no, $100,000. The fact that no one can agree on which number to use is the first sign the rule is wrong.
Here is the secret about these rules of thumb, accountants love them. They come up with these rules of thumb as way to offer “tax planning” so they get to charge more for their services. Once a business crosses this imaginary threshold that they’ve set, they can begin the work of converting the business to an S-Corporation, that means more money for the conversion and more money for the tax filing. They don’t care if it doesn’t make sense for that business, they care about what brings them more revenue. When you have a hammer, everything is a nail, and accountants swing their S-Corporation Hammer widely.
Rules of thumb, like these, allow us to begin thinking about these different strategies, but that is where they end. We should not rely on them for actual tax planning strategy or information. It should clue us in that now may be the time to explore these areas in more detail.
We saw how complicated this type of planning can get when we start exploring the nuances of making an S-Corporation election. As we showed in the previous section, even by bringing QBI into the calculations we can see how fast the tax savings can shift from sizeable savings to even costing us money.
A service business in Illinois (like Client B) making $750,000 in net profit has a completely different tax planning profile than a consultant making $80,000 in Texas.
The only way to tell is to ask yourself, “What does my actual situation look like?” The real answer is going to depend on your type of business, net profit, state corporate tax, and reasonable salary. All of these factors have the ability to shift a good idea into bad execution.
We can then dive deeper into the next set of factors such as business partners, spouses, retirement plans, pass-through-entity-tax election, health plans, etc. You can quickly see how fast the complexity grows when thinking about making an S-Corporation election and why “rules of thumb” should be left ignored.
The Salary Strategy: How to Pay Yourself the Right Way
What is reasonable compensation for an S-Corp owner? Reasonable compensation is the salary the IRS expects you to pay yourself based on your role, industry, and market rates. The IRS looks at comparable salaries for similar work in your region. Paying yourself too little creates audit risk; paying yourself too much means unnecessary payroll taxes. The goal is to find the salary that's defensible and efficient, not the lowest number you can justify.
The second and most dangerous rule of thumb shows up when talking about salary for an S-Corporation owner. We see different numbers being thrown around for how much salary a person should take compared to their distributions, 50/50, 60/40, 70/30, all different and all wrong. Like all rules of thumb, this one has no business being in tax planning. The IRS will NOT care about your rule of thumb.
We actually know this from a court case where reasonable compensation was based on a percentage, with the IRS subject matter expert stating, “Mr. Ostrovsky did not explain how a comparison of compensation measured as a percentage of gross receipts with compensation measured as a percentage of net sales would aid the Court in this case. In the end, we do not find this portion of Mr. Ostrovsky’s report to be persuasive or helpful.” Sean McAlary Ltd, Inc., Petitioner v. Commissioner of Internal Revenue, Respondent T.C. Summary Opinion 2013-62
Salary is the biggest single factor in making sure an S-Corporation election works correctly.
If we look back on how S-Corporations save on taxes versus their sole proprietor counter part, we see it is taking a business that is paying FICA taxes on 100% of the income and then reducing that to only paying FICA taxes on the salary portion of the income.
This naturally leads business owners to wanting to draw very small salaries to keep their FICA taxes at a minimum. Unfortunately, the IRS has already thought of that tax avoidance scheme.
To solve that issue, that IRS released guidance on how business owners should pay themselves, “S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly.”
They go on to say that if the business owner screws up their reasonable compensation, the IRS can go back and reclassify income as wages, “The IRS has the authority to reclassify payments made to shareholders from non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes). Several court cases support the authority of the IRS to reclassify other forms of payments to a shareholder-employee as a wage expense which are subject to employment taxes.” Citing one such court case where they reclassified wages, Joly v. Commissioner, T.C. Memo. 1998-361, aff’d by unpub. op., 211 F.3d 1269 (6th Cir. 2000).
Now that we understand how serious it is to get the reasonable compensation number correct, let’s look at the definition for reasonable compensation.
The IRS gives us guidelines how to develop a reasonable salary but it never gives us a clear formula for it.
There are three different approaches you can use to develop your salary number.
Cost approach, considers all tasks a business owner provides, how those tasks are divided by time and then assigns a wage to each task. This is the approach that we use when developing a reasonable compensation study. As a business owner, you are probably doing more than one job in the company. This is where the joke of, “yes I am an owner but also the janitor” comes into play. For us business owners, this is also known as the Many Hats Approach since we all wear many hats when running a company.
If you consider your normal 40 hour workweek, 2,000 hours a year, how can we divide up your jobs and responsibilities throughout that time? There are going to be jobs you do throughout the week that are your specialty, probably the reason you went into business in the first place. These are going to be your higher paying job, but there will also be jobs that you are just forced to take on because you can’t hire someone to fill that role. These are positions you probably don’t have any training for and little experience, these will be the lower paying jobs.
The first thing we do is divide up your time into roles, jobs, and responsibilities, making sure to highlight the experience and education level you have for each of those roles. We can then find comparable salary information to match those jobs, skills, experience, and education level.
If we look at a very basic example where a business owner spends 70% of their time in their specialty earning $100/hour and 30% of their time in admin work at $20/hour we can see how arrive at the reasonable compensation of:
2000 hours x 70% x $100 = $140,000
2000 hours x 30% x $20 = $12,000
Annual Compensation = $152,000
Compare that salary versus full time at the owners specialty:
2000 hours x 100% x $100 = $200,000
Annual Compensation = $200,000
By using the cost approach we were able to reduce the annual compensation by $48,000, thus allowing us to save in taxes and clearly define a reasonable compensation in the eyes of the IRS.
The next approach is the Market Approach. This method looks at similar businesses, same size and employee count, within the industry. This compensation number is based on what the owners or managers in those similar businesses get paid, and will use that number to set compensation. This is a good method to use when the business is a bit bigger and the owner doesn’t wear many hats.
The last approach is the Investor Approach. This approach is rarely used and only really used when the owner does not wear many hats and the business is an outlier so comparison data is harder to find. What would a hypothetical investor would consider the compensation justified based on the financial information of the company, that sets reasonable compensation.
Once you’ve established a reasonable compensation there are a few ways to play with that information.
First, you can’t pay yourself more than the business makes. We might have come up with a reasonable compensation of $152,000 but if the gross revenue is only $120,000 then we are going to need to back down our reasonable compensation number. As revenue begins to climb we may have to raise our reasonable compensation up to the $152,000 level that we calculated but we can do that over time as the business does better.
Second, you can play with timing. For business that are variable income due to contracts or seasonality, we can keep reasonable compensation lower at the beginning of the year and then true it up at the end of the year. This allows you to get a little more precise with your salary so you don’t run the risk of running too little (audit risk) or too much compensation (extra FICA taxes).
Getting salary right is not just about avoiding audit. It is also the key that unlocks one of the most powerful retirement savings tools available to business owners.
The Solo 401k + S-Corporation Combination
Can I have a Solo 401k with an S-Corporation?
Yes, and it's a powerful retirement and tax planning tool. Setting an S-Corporation salary can have a dramatic effect on the amount that you can put away into a Solo 401k.
A Solo 401k is an owner-only or owner/spouse-only 401k plan. That means you don’t have any other employees. It has all the same innerworkings of a normal 401k plan but it is cheaper and easier to implement. The reason is because there are less employees to worry about which means there is little to no testing that needs to be done on the 401k plan.
In 2026, the maximum contribution into a 401k plan is $72,000. This is made up of two parts, the employee contribution and the employer contribution. The employee contribution is limited to $24,500 and the employer contribution is limited to 25% of salary (or $72,000, whichever is less).
Employer retirement plans, such as the Solo 401k, are great vehicles to simultaneously save on taxes and build wealth, and it all starts with your reasonable compensation.
The employee portion of your 401k is usually pretty easy to meet, as long as your salary is over $23,500, you can make the full employee contribution to the 401k. If this money is going into a pre-tax or traditional 401k, this will be a tax deduction.
The employer portion will be limited to 25% of your W2 wages. If your W2 wage was $100,000, you could contribute $24,500 to your employee portion and $25,000 to your employer portion for a total contribution of $49,500. The employer contribution is a deductible expense to your business, so another tax deduction.
This is where we have to thread the needle between keeping our reasonable compensation low to save on taxes and high enough to max out our 401k contribution.
When we looked at the tax plan for Client A, we set his reasonable compensation to $186,000. This was higher than the reasonable compensation we calculated using the cost approach from the previous section. This was done so we could make a $31,000 employee contribution (due to catch-up contribution amount) and a $46,500 employer contribution to max out at $77,500 in pre-tax. We pulled that money out of taxable income to grow our tax-deferred retirement account.
As you can see, we are starting to stack our tax planning strategies to create a balance between paying less in taxes and building real wealth. At $77,500 per year going into a tax-deferred account, a business owner in their peak earning years could accumulate well over $1,000,000 in retirement savings before investment growth compounds that balance.
The PTET Election: An Underused Tax Deduction
What is a PTET election and how does it save taxes?
A Pass-Through Entity Tax (PTET) election lets your S-Corp pay state income tax at the business level rather than passing it to your personal return. Because the SALT deduction on personal returns is capped at $40,000, high-income business owners lose significant deductions. The PTET routes state taxes through the business return where they're fully deductible federally, effectively recovering state tax deductions that would otherwise be capped.
The Tax Cuts and Jobs Act (TCJA) really turned itemized deductions upside down. To force more taxpayers to take the standard deduction, thus making taxes “easier”, they limited the State and Local Tax (SALT) deduction to $10,000. This really affected people in high tax states which now saw their itemized deductions greatly reduced.
Since Tax Cuts and Jobs Act, the One Big Beautiful Bill (OB3) has increased the limit from $10,000 to $40,000, making it much easier for people to take advantage of itemized deductions. These deductions are still limited to a phase-out so there is a good chance for a high earning business owner to still be limited to $10,000.
In response to TCJA, states created a workaround to still get people their deduction. That workaround is known as the Pass-Through Entity Tax (PTET) election. PTET allows business owners to pay their state taxes directly through their business and receive a credit on their personal return.
In most pass through entities, like an S-Corporation, where taxes pass through the business and on to the personal return, companies don’t pay most taxes directly. They are just a vessel. That means any taxes paid by the business on behalf of the taxpayer was a personal expense, not deductible, and considered a distribution.
PTET fixed that. PTET said, we will allow you to elect into PTET, pay your state taxes directly from your business, have it be a deductible business expense, and give you a credit for that payment on your personal return.
An amazing tax planning strategy was born.
PTET is available in most states but not all, and every state has a different set of rules for how to elect and pay PTET. In a lot of states, like California, there is a special tax rate for PTET, 9.3%. This means that electing PTET is not always a “YES”, it does require additional planning because you could be paying a higher tax bill overall by electing into PTET than if you just passed the taxes onto your personal return.
If we look at our Client A example, this taxpayer had an S-Corporation in Massachusetts where PTET is available. The tax rate for Massachusetts PTET was 5% on qualified income. In return Massachusetts gave a 90% refundable credit back to the shareholder. As you can already see, it’s not always clear that PTET is going to be an automatic tax saving strategy as Massachusetts only gave credit for 90% of the taxes paid, meaning there is a net cost of 10%.
In this case, it was a slam dunk, they were able to get a $57,194 federal tax deduction and save approximately $22,000 in Federal taxes for only a 10% cost of the Massachusetts credit.
Before electing into PTET make sure you understand your state’s rules. A lot of states have very strict deadlines and requirements to elect into PTET, and if you don’t follow them, it will disallow the deduction.
PTET is one of the few strategies that delivers a meaningful federal tax benefit purely through proper state-level planning, which is why it belongs in every S-Corporation conversation.
The Spousal S-Corporation: Stacking the Strategy Further
Can I employ my spouse through my S-Corporation to save on taxes?
Yes, if your spouse performs legitimate work in the business, employing them through the S-Corporation allows you to add a second salary, increase retirement plan contributions, and stack additional deductions on top of your existing S-Corporation strategy.
Having a spouse or child that can work in the business with you allows you to stack the strategies we’ve been discussing for additional tax savings.
When a spouse has the ability to legitimately work in the business, we can use them to increase our deductions through payroll, health insurance, and more importantly, retirement plans.
Being able to give them a salary and then dedicate that salary to a 401k plan is another great way to reduce income and build long-term wealth in a retirement plan.
Looking back on Client A, when we built their tax plan, we noticed that their spouse was already helping them with a lot of administrative work but wasn’t actually being paid for it. We were able to do a reasonable compensation analysis for the administrative work and settled on a salary of $35,000/year.
Due to the 401k catch up provision because of her age, we were able to defer $31,000 into the employee portion of the 401k. The combined household retirement savings went from $77,500 to $117,250 a year.
On top of the additional wealth building, the combined federal and state taxes dropped to $491,440 vs $634,114 when there was no strategy. A tax savings of $142,674 a year!
With any tax strategy, compliance is the most important caveat. You cannot “employ” every family member because there is tax savings if they don’t have an active part in your business. That is not tax strategy, that is tax avoidance. There must be real, documented, purpose for every person employed in the business for it to be an effective tax strategy.
Employing children in the business is another variation of this strategy and worthy of its own dedicated article.
When an S-Corporation is NOT the Right Move
When does an S-Corporation cost more than it saves?
When the cost of additional compliance, including professional tax preparation, payroll services, and bookkeeping software, exceeds the tax savings from the election. For lower-profit businesses or those in certain states, the math does not always work in the S-Corporation's favor.
S-Corporations can be amazing business structures that lead to a lot of tax planning opportunities. As we’ve already seen, the tax savings can start with the ability to split salary and distributions, but with the stacking of retirement plans, PTET, spousal hiring, the tax savings can get exponential.
That still doesn’t mean making the S-Corporation election is for everyone. It can be a costly tax strategy if you make the election at the wrong time or without thinking about all the repercussions. We’ve advised many clients that even though the tax savings was there, the additional compliance work was not in their best interest and to avoid making the S-Corporation election.
Since we’ve already highlighted the tax aspects of an S-Corporation and when they may not be right for everyone, let’s focus on the compliance aspect.
Filing an individual return (Form 1040) and an S-Corporation tax return (1120-S) are two different beasts. While it is okay to tackle the individual yourself, you should avoid filing the S-Corporation yourself. There are a lot more moving parts in an S-Corporation tax return that need to be reconciled and followed properly.
When you are considering the tax savings of your election, factor in the cost to have your Form 1120-S professionally prepared.
With an S-Corporation also comes payroll. There is no getting around it, you have to run payroll, at least for the business owner if you don’t have any other employees. You will want to hire a service to run payroll, like Gusto. They will properly withhold the right amount of federal and state taxes for you, file the proper 940/941 payroll forms and state payroll forms, and send out W2’s at the end of the year. All things that are required of an S-Corporation. This equals more compliance and more fees.
States can also throw in their own compliance headache and costs. Some states have a franchise or corporate tax rate that will be triggered with the S-Corporation election. For example, California requires a $800 minimum yearly payment, or 1.5% on net income, whichever is higher, for their franchise tax.
Your tax savings is starting to dwindle.
The final major piece of compliance consideration is bookkeeping. It is easy to get by without bookkeeping when you are filing on a Schedule C of the Form 1040, but once you become an S-Corporation, you need to put official bookkeeping in place. That doesn’t mean you need to hire someone, but you do need to have an actual system/software to handle bookkeeping, something like Quickbooks.
With S-Corporations there are a couple of nuances to recognize in the books. You need to set your capital stock when you make the conversion, this goes on your balance sheet. You will also need to track your payroll and distributions to properly account for money coming out of the company. On the Form 1120-S, you will be asked to recreate your balance sheet to file with the IRS, this is done on Schedule L. This is why it is important to have a system that tracks these balances and retained earnings for you as you build and run your business. On a Schedule C, you can skip over all of those items, as you don’t send your balance sheet to the IRS.
As you can see, an S-Corporation requires you to put systems and processes in place that you did not need before. This not only increases costs but also time. Compliance work is not the area you want to skimp on.
Don’t let the tax tail wag the dog.
Putting It All Together: The Full Picture
How much can an S-Corporation actually save in taxes?
It depends on your situation, but when you stack an S-Corporation election with a Solo 401k, PTET election, and spousal employment, the combined savings can exceed six figures annually. The examples below are real client outcomes, not projections.
With a clear picture of what the S-Corporation requires, let’s return to our two Clients from the introduction to see what the math looked like when everything came together.
Client A was an active stock trader in Massachusetts. He was retired but was an active trader post retirement, he was very successful with capital gains of more than a million dollars. His wife was also retired, and helped him with some administrative work for the business.
They came to us with a tax bill of $634,114. We went to work.
Capital gains by themselves don’t allow you to put money into retirement accounts, you need earned income for that. We moved to creating an LLC and electing S-Corporation status to turn short-term capital gains into ordinary/earned income. We were able to do this for this individual because he qualified for Tax Trader Status by the IRS.
Making this election, we could now deduct expenses against his trading, home office, software, research, travel to conventions, were all ordinary and necessary business expenses that could now be deducted. Before the election, these expenses were lost.
We analyzed what tax savings would be if we added a 401k plan, by maxing out his Solo 401k plan he lowered his tax bill to $520,418, a tax savings of $113,696.
We looked further to electing PTET in Massachusetts, lowering the tax bill to $504,975, increasing the savings to $129,139.
We are not done yet.
Finally, we did a reasonable compensation study on his wife for the administrative work she was already doing in the business. This allowed us to pay her, increase deductions, and set up a 401k for her retirement contributions. This lowered the tax bill to $491,440, a $142,674 tax savings a year!
Client B was a medical practice owner in Illinois. They had just completed their first year of business and got hit with a whopping $291,405 tax bill. It seems success has its costs.
They already had an SEP IRA in place for the practice but it was not doing enough for them. The retirement and tax savings were minimal.
We built a plan that looked at what an S-Corporation could do for them. We also saw this as the perfect opportunity to drop their SEP IRA retirement account and replace it with a 401k plan. A Solo 401k allowed them to contribute significantly more than the SEP IRA which made it the ideal retirement vehicle.
These two items alone saw their tax bill drop to $201,206, a tax savings of $90,199 a year! This tax savings increased their cash flow and allowed them to purchase new and much needed equipment for the business.
The difference between no strategy and the optimized tax strategy is not a rounding error. It is a paid off car, new house, new employee to free up your time. It’s a fully funded retirement account every year. It’s financial momentum instead of just a tax bill.
How to Get Started with your S-Corporation Election
How do I get started with an S-Corporation election?
Start by reviewing your last two years of tax returns to understand your current tax profile, then analyze your reasonable compensation, available deductions, retirement plan options, state tax rules, and compliance costs before making the election.
Analyze: When thinking about making an S-Corporation election, you want to start by analyzing your tax returns. This is a good snapshot of how your business has performed over time. Ideally, you want to start with the last two years. If your business is brand new and never filed a tax return, then you want to start with your profit and loss reports.
Calculate: One of the major factors that determines tax savings is your reasonable compensation. Look at the time you spend in the business and what jobs you are doing to get a clear picture of how to divide your work day. Use industry benchmark data to come up with salary ranges for each of those jobs and use them to develop an annual salary range that is reasonable.
Identify: Look for additional deductions that can now be taken with your S-Corporation. Every additional deduction we can add that is an ordinary and necessary business expense is one less dollar we have to pay tax on.
Plan: Always consider your ability to add on different types of retirement accounts. Even though the Solo 401k is usually a better retirement account, it is not the only one to consider. A SEP IRA, cash balance plan, or defined benefit plan could be better for high-income low employee business owners.
Research: One of the most important aspects is how your state will be involved. Make sure you check the rules, tax rates, and understand the filing requirements for your state. This is also a good time to research PTET and see if your state makes it available and how it can support your tax strategy.
Account for: Finally, if you have a spouse already doing work in the business, or could be working in the business, make sure you account for them too in this calculation.
Evaluate: At the end of the day, even if the tax savings are there, make sure you are up to the extra compliance work that comes with electing S-Corporation status.
Don’t use rules of thumb in your planning as the IRS won’t when they audit you.
This is exactly the work we do at Bullogic Wealth before any client makes a structural decision. Every situation is different and the difference between a good plan and a great one is usually in the details most people overlook.