Being taxed as an S Corporation certainly has its advantages.
That’s something you may hear quite often, but what does that actually mean?
Let’s take a look at two simplified examples:
You have a sole proprietorship, you receive $100,000 in income. How is that taxed?
There is a self-employment tax of 15.3% on the $100,000 ($15,300.00).
That $100,000 is also subject to income tax.
Now let’s say you have a company that is being treated as an S Corporation. Company receives $100,000 in income. How will that get taxed?
Assuming $50,000 of that $100,000 goes to you as salary and the other $50,000 as a distribution, you pay your payroll tax (also happens to be 15.3%) on the $50,000 salary ($7,650)
That remaining $50,000 distribution is subject to income tax.
You save potentially a lot of money in taxes from having a company that elects to be treated as an S Corporation. There are some other limitations on this scenario but these are the basic principles when one refers to the Self Employment Tax Shield i.e. a shield against having to pay high self-employment taxes.