Restructuring Business Entity to Minimize Social Security Payroll Taxes

What is restructuring a business entity?Restructuring Business Entity to Minimize Social Security Payroll Taxes

Restructuring your business entity can minimize Social Security taxes

If you own a business as a sole proprietorship, you may be able to minimize the Social Security taxes you pay by incorporating your business and causing the business to elect to be taxed as an S corporation. If your business is treated as an S corporation for federal income tax purposes, then you may be able to continue to benefit from a single level of tax on your business earnings, while minimizing the portion of your business earnings that are treated as wages or self-employment income subject to Social Security taxes.

How does it work?

S corporation owners are considered employees of the corporation

If you own a corporation and perform substantial services as an officer of that corporation, you’re not treated as self-employed for tax purposes; rather, you’re treated as an employee of the corporation. Because you’re not self-employed, you don’t pay self-employment taxes. However, as an employee, both you and the corporation have to pay Social Security payroll (FICA) taxes on your salary. If you’re both an officer of your corporation and a shareholder, you may be able to reduce the amount of FICA tax you pay by receiving some of your compensation as corporate dividends.

Corporate dividends can reduce your payroll taxes

As a shareholder, you can withdraw earnings from your corporation in the form of dividends. You won’t have to pay Social Security payroll taxes on that part of your corporation’s earnings, because investment income is not subject to FICA taxes. You will only pay FICA taxes on the wages you receive from the corporation.

Strengths

You can reduce the amount of Social Security payroll taxes you owe

Incorporating your business and causing it to elect to be taxed as an S corporation can save you money by reducing the amount of Social Security payroll taxes you owe if, as a shareholder of the corporation, you withdraw part of the corporation’s earnings in the form of corporate dividends, rather than withdrawing such earnings as wages.

Tradeoffs

Setting up a corporation can be expensive

Operating a sole proprietorship is simpler and less expensive than operating a corporation. If you incorporate your business and elect for it to be taxed as an S corporation, you will have to pay incorporation fees, and you may have to hire accounting, tax, or legal professionals to advise you. There are a number of requirements that must be satisfied for a corporation to be eligible to elect to be taxed as, and continue to qualify as, an S corporation.

The Internal Revenue Service (IRS) may challenge your compensation structure

The IRS may audit your business and it may recharacterize all or a portion of any dividends distributed by the corporation to you as wages if it believes that the corporation is paying you compensation that is unreasonably low in order to avoid Social Security taxes. To avoid this, you must pay yourself an annual salary that is reasonable considering the work you actually do for the corporation during the year. (The IRS may, in certain circumstances, challenge unreasonably high compensation as well.)

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Broadridge Investor Communication Solutions, Inc. prepared this material for use by Social Security Benefit Planners, LLC.

Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances. Social Security Benefit Planners, LLC  provide these materials for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Social Security Benefit Planners, LLC and its affiliates are in no way associated with or approved, endorsed, or authorized by the Social Security Administration.

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