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  • S-Corp distribution tax rate

    I’m in the process of converting my LLC (single member) to filing as an S-Corp. I’m confused about how distributions are taxed. I’ve read on several blogs that the tax savings on distributions is 15.3% due to exemption from self-employment tax, but on WCI S-Corp articles the tax benefits are said to be 3.8% on distributions. I think this is also the number my CPA quoted. Can anyone speak to this discrepancy? Any insight would be appreciated!

  • #2
    It’s a little complicated, but you’ll pay FICA tax of 15.3% on the 1st $142,800 in earned income (i.e. wages from your S-corp) and 3.8% on earned income above that amount. Most s-corp owners pay themselves at least enough to maximize their solo-k contributions (don’t let your CPA talk you into a SEP IRA), which is above the $142,800 wage base. In this case, distributions will save you the 3.8% Medicare tax part of FICA (the other part is the SS tax of 12.4% on the 1st $142,800.

    I won’t get into other advice about how to structure your income, you have a CPA for that. But I will advise that it may not be a good idea to form an s-corp below ~$400k net income (including your salary but after other deductions) and even higher if you’re in CA or TN. Of course, some physicians are required to form s-corps to belong in certain groups, and it is not a choice.

    Good luck and welcome to the forum!
    Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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    • #3
      Minor point, self-employed Medicare taxes are only 2.9%.

      The additional 0.9% Medicare surtax doesn't apply until earned income is > ($200K S/$250K MFJ). It is not part of SE taxes.

      Also, is the LLC your sole means of earned income or is it in addition to other W-2 wages? If the latter and W-2 wages will be > $142,800. Electing to treat the LLC as an S-Corp will most likely be counter-productive.

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      • #4
        Thank you for your responses!

        The LLC is my sole means of income. I expect my net income to be around 250K.

        So, if I understand correctly - I will still be taxed 12.4% on the first $142K of distributions?? This doesn’t make the tax savings on distributions all that great.

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        • #5
          Originally posted by spiritrider View Post
          Minor point, self-employed Medicare taxes are only 2.9%.

          The additional 0.9% Medicare surtax doesn't apply until earned income is > ($200K S/$250K MFJ). It is not part of SE taxes.

          Also, is the LLC your sole means of earned income or is it in addition to other W-2 wages? If the latter and W-2 wages will be > $142,800. Electing to treat the LLC as an S-Corp will most likely be counter-productive.
          Thank you lol. Of course, I knew that - I guess it was too early and the amount he provided imprinted on me.
          Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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          • #6
            Originally posted by Jospok View Post
            Thank you for your responses!

            The LLC is my sole means of income. I expect my net income to be around 250K.

            So, if I understand correctly - I will still be taxed 12.4% on the first $142K of distributions?? This doesn’t make the tax savings on distributions all that great.
            This really makes no sense. When you consider the loss of 199a deduction + the additional administrative costs of payroll prep and tax prep, you will be on the negative. I hope you will reconsider.
            Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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            • #7
              Originally posted by jfoxcpacfp View Post

              This really makes no sense. When you consider the loss of 199a deduction + the additional administrative costs of payroll prep and tax prep, you will be on the negative. I hope you will reconsider.
              Agreed. S corp sounds questionable.

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              • #8
                Originally posted by Jospok View Post
                The LLC is my sole means of income. I expect my net income to be around 250K.

                So, if I understand correctly - I will still be taxed 12.4% on the first $142K of distributions?? This doesn’t make the tax savings on distributions all that great.
                With $250K in net income, reasonable compensation is likely to be in the neighborhood of $142,800.

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                • #9
                  Thank you, will definitely be reconsidering

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                  • #10
                    Definitely pump the brakes. Perhaps unneeded but to clarify terms. If you are an s-corp you need to pay yourself a reasonable salary (w-2). The additional income can be distributed. The W2 income is taxed as W2 income. The distribution is exempt from payroll tax.

                    For a physician a reasonable salary is almost certainly going to be over $142,800 so you are still going to pay the full social security tax withholding. So, the advantage at higher income is avoiding the medicare tax that does not have a cap. Perhaps the blogs you are reading are discussing s-corp for lower income situations where a reasonable salary is less than the social security maximum.

                    As others have said changing to an s-corp is likely mathematically the wrong choice for you.

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                    • #11
                      If I make 400,000 as a W2 associate, and then 900,000 as partner, can I continue using 400K as my 'reasonable salary' moving forward after becoming partner

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                      • #12
                        Originally posted by GastroMastro View Post
                        If I make 400,000 as a W2 associate, and then 900,000 as partner, can I continue using 400K as my 'reasonable salary' moving forward after becoming partner
                        Depends on facts and circumstances. I would lean toward being comfortable with it as you did not magically become more valuable by transitioning. Rather, you are utilizing the synergy of the partnership to make more $$. Again, other factors may impact, but it w/b rare for me to see a partner (and I am presuming you mean s-corp shareholder, b/c W2 wages are inappropriate for partners in a partnership) with wages above that threshold.
                        Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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                        • #13
                          Originally posted by jfoxcpacfp View Post

                          Depends on facts and circumstances. I would lean toward being comfortable with it as you did not magically become more valuable by transitioning. Rather, you are utilizing the synergy of the partnership to make more $$. Again, other factors may impact, but it w/b rare for me to see a partner (and I am presuming you mean s-corp shareholder, b/c W2 wages are inappropriate for partners in a partnership) with wages above that threshold.
                          Then I would be saving 500K * 3.8% = $19000 a year on the Medicare tax? Minus CPA fees for the S-corp.

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                          • #14
                            While I generally agree with jfoxcpacfp, I would lean on the facts and circumstances a little more. The fact that you went from an associate to a partner indicates a more senior position. Where you might have received a merit pay raise even if not made a partner.

                            The IRS and recent court cases on reasonable compensation do place a strong emphasis on what someone with your knowledge, skills and experience would make in your COL area. However, just leaving it at that one fact and circumstance misses other facts and circumstances.

                            They have also indicated that a self-employed individual may have other (management, marketing, financial, etc...) responsibilities requiring additional compensation. Therefore, consider your prior W-2 wages as not necessarily reasonable compensation.

                            While only you and/or a professional can fully appreciate your facts and circumstances. A reasonable compensation of a nominal 5% - 15%% higher than your W-2 wages, might be appropriate.

                            Personally, I don't understand when people pick exactly the minimum reasonable compensation (2020 = $154K) necessary to maximize one-participant 401k annual additions (2020 = $58K). They can't pay themselves $160K to not be so obvious what they are doing.

                            I might be inclined to do something similar here. I might pay myself at least $35K/month * 12 = $420K/year to show a small bump as partner. The extra ($20K * 3.8% = $760/year) is not going to break you and you are still saving $480K * 3.8% = $18,240/year.

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                            • #15
                              I have a question regarding this, and a tax friend of mine said he wasn't worried at all about a reasonably low salary level for your gig, he said they are unlikely to come after you if a CPA files and beyond that, they'll just tell you to remedy it if it even happens (they "threaten" you).

                              The question I have regarding the LLC/S Corp part is incorporating in a great business state and sending yourself distributions (as per usual) to yourself in the residence state. He said this is complicated and seemed more tax attorney type stuff, but I fail to see any issue if the states in question are no income tax states (ie, they don't care or wouldn't be definition come after you). The reason this might be important would be if you live in a state where businesses are taxed, so the corporation is thus elsewhere and the distributions are sent to you, but that's personal income and in the no income tax state, goes untaxed. Feds get what they get, no one otherwise knows or cares. Don't a lot of people do this already? The accountant in question acted like you needed some ID in the incorporated state but I thought that's what registered agents are for, they are quite well advertised everywhere.

                              Thanks if you can shed light on this topic.

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