SE tax: Solo proprietor vs. Single member S-Corp

[danut15]

Now now I see where I was mistaken. Was calculating it as a credit instead of taking a marginal tax bracket deduction. You're right! Thanks for clarifying that!

I think we both agreed that even so, the amount is too small to even bother with the added complexity of the S corp after all other required expenses.

[spiritrider]

This is where your problem is; "since 1/2 of the SE tax is also deductible for the solo on their 1040 anyhow, hence 2.9% becomes 1.45%, while 0.9% stays the same." The SE tax does not change,  the 1/2 SE tax deduction only partially offsets it.

First, let's agree we are trying to determine the difference between the FICA of an S-Corp and the SE tax of the self-employed.

Next, they both pay the same amount on the first $200K, the S-Corp FICA on $200K of W-2 wages and the self-employed SE tax on the first $200K of earnings.

Since the S-Corp will pay nothing other than FICA on wages, the $150K is only subject to SE tax and the 0.9% surtax for the self-employed.

Here is what the self-employed person will pay more in SE taxes than the S-Corp W-2 shareholder-employee will pay in FICA:

1. $150K * 2.9% = $4,350, Form 1040 Line 57, Self-employment tax, from Schedule SE


2. $150K * 0.9% = $1,350, Form 1040 Line 62, from Form 8959 Additional Medicare Tax


3. $4,350 / 2 = $2,175, Form 1040 Line 27, Deductible part of self-employment tax, from Schedule SE

This is what I have been trying to explain to you. The taxes on the additional $150K in self-employment income are $4,350 + $1,350 = $5,700. Line 27 is not a credit of the 1/2 SE tax, it is a deduction against income of the 1/2 SE tax, so you have to consider the marginal tax rate. At a marginal rate of 33%, Line 27 reduces the income tax by $718.

The net effective employment taxes on $150K is $4,350 + $1,350 - $718 = $4,982.

[danut15]

spiritrider wrote:

danut15 wrote:

Just to clarify, the calculation for the S-Corp savings (as a tax deduction) is: 1.45%*distributions (K1)+0.9% * all distributions above 200K. So if one takes a salary of at least 200K, then the SE tax savings are=1.45%+0.9%= 2.35%* all distributions above 200K. Considering cpa fees and as someone else mentioned payroll fees for the S corp between 1500-3000$, this all starts making sense if you can take at least 150K as distributions, where the savings would be 2.35%×150,000=3525$.

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As I mentioned in the beginning of my previous post, Form 1040 Line 27 (1/2 SE tax) is a deduction not a credit.  So the S-Corp FICA savings on $200K W-2 salary, $150K distributions and 33% likely marginal tax rate = 1.45% + 1.45% (1 – 0.33) + 0.9% = 3.3215% * $150K = $4,982. Don’t forget other employment taxes. E.g. FUTA, SUTA, workman’s compensation insurance in a few states, etc…

As stated by Johanna, at $5K in savings on $350K in net business income, you are starting to reach the point where it may be beneficial to have an S-Corp.

However, as pointed out in the recent posts, CA and many other states have S-Corp specific taxes/fees to add to the mix. Then add in payroll, tax planning/filing costs, etc… They can all add up to reduce/eliminate the S-Corp employment tax benefit. Then even if you save $1K or $2K per year, you have to judge whether that net cost savings is worth your extra time, hassle and aggravation.

 

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Spiririder, just for calculation purposes, I think we are referring to the same facts, but with different angles:

1. The amount you mentioned refers to the entire SE tax for the S-corp; my point of view was looking at what the savings=agree, as tax deductions, are between S corp and solo, since 1/2 of the SE tax is also deductible for the solo on their 1040 anyhow, hence 2.9% becomes 1.45%, while 0.9% stays the same.

2. I left out the tax bracket from the calculation, since it may vary for some other individuals a bit

3. So if we compare what the S corp savings, as a tax deduction, are (over the solo 1/2 SE tax deduction), it comes to:

1.45%+0.9% (over 200k)=2.35%*dividends= as tax deduction improvement in addition for the S-corp, to what the solo would have anyhow saved (the other 1.45%)

4. I agree, S-corp is too much hassle adding everything else up.

 

[spiritrider]

danut15 wrote:

Just to clarify, the calculation for the S-Corp savings (as a tax deduction) is: 1.45%*distributions (K1)+0.9% * all distributions above 200K. So if one takes a salary of at least 200K, then the SE tax savings are=1.45%+0.9%= 2.35%* all distributions above 200K. Considering cpa fees and as someone else mentioned payroll fees for the S corp between 1500-3000$, this all starts making sense if you can take at least 150K as distributions, where the savings would be 2.35%×150,000=3525$.

Click to expand...

As I mentioned in the beginning of my previous post, Form 1040 Line 27 (1/2 SE tax) is a deduction not a credit.  So the S-Corp FICA savings on $200K W-2 salary, $150K distributions and 33% likely marginal tax rate = 1.45% + 1.45% (1 - 0.33) + 0.9% = 3.3215% * $150K = $4,982. Don't forget other employment taxes. E.g. FUTA, SUTA, workman's compensation insurance in a few states, etc...

As stated by Johanna, at $5K in savings on $350K in net business income, you are starting to reach the point where it may be beneficial to have an S-Corp.

However, as pointed out in the recent posts, CA and many other states have S-Corp specific taxes/fees to add to the mix. Then add in payroll, tax planning/filing costs, etc... They can all add up to reduce/eliminate the S-Corp employment tax benefit. Then even if you save $1K or $2K per year, you have to judge whether that net cost savings is worth your extra time, hassle and aggravation.

 

[danut15]

Just to clarify, the calculation for the S-Corp savings (as a tax deduction) is: 1.45%*distributions (K1)+0.9% * all distributions above 200K. So if one takes a salary of at least 200K, then the SE tax savings are=1.45%+0.9%= 2.35%* all distributions above 200K. Considering cpa fees and as someone else mentioned payroll fees for the S corp between 1500-3000$, this all starts making sense if you can take at least 150K as distributions, where the savings would be 2.35%×150,000=3525$.

[pistolpete]

I'm in California also and I'll be opening up my private practice soon, and I will be a sole proprietor for all the reasons mentioned above.

[Zaphod]

Im in Cali and operate as an SP for exactly these reasons. Its expensive, much more complex and for nearly nothing. Read a lot of fancy and promise filled tax/corporation forming books before starting out, all to realize for docs there was minimal benefit.

[spiritrider]

OP, you are spot on with your basic analysis, but a small correction with your calculations. The 1/2 SE tax deduction only decreases the net effective SE tax by your marginal tax rate. So with a marginal tax rate of 33%, the S-Corp savings is ~2.4%. it is only 1% more and doesn't materially affect the analysis.

1. Johanna and I have been trying to counter this persistent myth that a white coat should "always" create an S-Corp. Unfortunately, a lot of the drivers of this are CPAs and other finance professionals. I do not know whether it is lack of understanding, habit or self-interest. I do know that the CPAs and finance professionals here on WCI have none of those deficiencies.

2. An S-Corp should almost never be used for non-wage income when you already have W-2 Social Security (SS) wages >= SS maximum wage base (2017= $127,200). Unless you have extremely rare circumstances, you will pay "more" in S-Corp FICA, than you would have in Self-Employed SE tax. Yet, we see time after time where white coats have been advised to use one.

A caveat about items 3&4. IRS guidance is that if most of the income is from the personal services of an owner, them most of that income should be paid as compensation. Item 5 will consider other situations.

3. It may be counter intuitive, but the optimal case for an S-Corp is where that is your only source of earned income and it is at moderate income levels. Specifically, a net profit <= (SS max wage base / 0.9235), 2017 ~= $137,750. In this case any distributions and employer retirement plan contributions save you 15.3% in FICA over the equivalent SE tax.

4. As Johanna pointed out, if your net profit is greater than the above amount, you need substantial additional net profit/wages to offset state/local annual fees, corporation specific taxes (franchise, gross receipts, etc..) and tax planning/filing fees to tax/financial professionals. As identified by you, you do not realize the full FICA savings on distributions and employer contributions. As your income rises, your marginal tax rate rises, the 1/2 SE tax deduction rate rises.

5. DMFA's point is also important to consider. The IRS guidance on reasonable compensation does allow that if the majority of income is from the services of employees, sale of products, return on capital, etc..., Reasonable compensation can be less than distributions.

This means that an S-Corp is generally the best choice for a practice or other business meeting the above criteria.

[Antares]

I’ve consistently maintained a sole proprietorship for just the reasons given, as advised by my accountant.

[jfoxcpacfp]

danut15 wrote:

Some accountants out there “advise” physicians to incorporate and do a single member S -Corp because of the potential savings on SE tax. I have a question by using a simple example to see how much truly these savings are:
Will assume a SS salary limit of 127,000 and a total annual net income of 300,000. Out of the total net income, under the S Corp status, the physician let’s say takes 225,000 as W2 income and 75,000$ as dividends (K-1 schedule). The 75,000 would basically not be subject to SE tax under the S Corp and taxed at 2.9% Medicare tax and 0.9% Medicare surcharge tax (on income over 200K) for the solo proprietor. However since half of SE tax would be anyhow deductible on Federal taxes (1040) for both under the S corp and solo proprietor, then the true savings of S Corp vs. Solo in regards to saving on SE tax are half of 2.9% ×income taken as dividends= 1.45%*75000 +0.9%*75000=1762.50$. Considering that the accountant cost of filing S corp taxes and your personal taxes are 1500-3000$/year depending on complexity, it seems that there is no true $ advantage/savings to unnecessarily complicate yourself as physician with the S corp status. Am I correct in this assessment?

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You're correct. I've made this point many times on this forum. You also should include the cost of preparing payroll and compliance with all fed/state/local tax laws. The breakpoint is generally around $300k - $350k gross receipts (depending upon the fees you pay your CPA). If you'd like a copy of the Excel spreadsheet I've made to evaluate for clients, pm me your email addy or email me at [email protected]

[DMFA]

True, plus you're not supposed to take a K-1 on work that you're actually doing yourself. Unless you're in a state that requires self-employed physicians to operate as S-corp like California, or you bring in revenue from things other than work you perform (sales, others' work, etc), you're likely best off as a sole prop.

[danut15]

Some accountants out there "advise" physicians to incorporate and do a single member S -Corp because of the potential savings on SE tax. I have a question by using a simple example to see how much truly these savings are:
Will assume a SS salary limit of 127,000 and a total annual net income of 300,000. Out of the total net income, under the S Corp status, the physician let's say takes 225,000 as W2 income and 75,000$ as dividends (K-1 schedule). The 75,000 would basically not be subject to SE tax under the S Corp and taxed at 2.9% Medicare tax and 0.9% Medicare surcharge tax (on income over 200K) for the solo proprietor. However since half of SE tax would be anyhow deductible on Federal taxes (1040) for both under the S corp and solo proprietor, then the true savings of S Corp vs. Solo in regards to saving on SE tax are half of 2.9% ×income taken as dividends= 1.45%*75000 +0.9%*75000=1762.50$. Considering that the accountant cost of filing S corp taxes and your personal taxes are 1500-3000$/year depending on complexity, it seems that there is no true $ advantage/savings to unnecessarily complicate yourself as physician with the S corp status. Am I correct in this assessment?