You have likely heard about the tax savings benefits of S Corporations and have always wondered, is it right for me?
S Corporations are not right for everyone!
We have this conversation with clients all the time and we don't typically start running the numbers to consider electing S Corporation status until the business is "netting" at least $50k.
Why is that?
There are costs to running an S Corporation that may not apply to LLCs and Sole Proprietorships.
The tax savings achieved by S Corporations need to cover the costs; otherwise, you are paying for the extra admin of S Corp status and not getting the tax benefits.
We cover these costs below.
1. S Corporations must have owners on payroll
Annual cost - $550+
Unlike Sole Proprietorships and LLCs where owners are never on payroll, S Corporations must pay their shareholders a reasonable salary and issue W2s.
We always recommend outsourcing payroll for small businesses as it's too easy to make very expensive mistakes.
Gusto, ADP, and Paychex are among the most popular.
For Gusto's entry-level plan, it is $40/month + $6/employee.
Annual payroll processing cost for one shareholder = $552
2. Filing a Tax Return
Annual cost - $800 - $1,500
S Corporations must file a tax return for the entity. The entity doesn't pay federal income tax unless elected to do so.
Instead, the net earnings pass through to the shareholder owner's individual returns via K-1 packages.
The preparation of the entity tax return and filing is not something we ever recommend for TurboTax. cringe
In fact, many tax preparers who specialize in individual returns may even turn away S Corporation filings.
You want to find a tax preparer well-versed in S Corporations and S Corp tax saving strategies!
Hiring a tax preparer to prepare and file your annual tax return for your S Corporation will cost $800-$1500.
3. Annual Franchise Tax and State Filings
Annual cost - varies by state
If you have an LLC, you already pay these same annual franchise taxes to your state.
If you are lucky, you live in a state like Montana or Michigan where annual franchise tax and filing fees are $25-35.
Or if you live in California, you pay the larger of $800 or 1.5% of your net income to the state, plus a $20 every-other-year Statement of Information filing fee.
Note: some states like Tennessee don't have individual income taxes and do assess a business tax at the state level.
These costs may come as a surprise to some and warrant being mentioned.
That said, if you have an LLC, you are likely already paying these fees to your state.
4. Bookkeeping
Annual cost - $420 - 4,000
Keeping accurate company books is a requirement for S Corporations.
Spreadsheets may have been sufficient for LLCs and Sole Proprietorships, but a legit S Corporation should have company books, using bookkeeping software.
Not only must you keep business and personal books separate, but we also find this step to be a gatekeeper to measure whether a business owner is ready to run an S Corporation.
S Corporations do require more formality, admin, and documentation. Nowhere near as much as a C Corporation, but it is a step up in paperwork from an LLC.
Not all business owners are ready for it.
Bookkeeping is a necessary tool to provide up-to-date numbers to business owners as the CEO to make profit-driven decisions.
QuickBooks Online and Xero are our favorites, both robust and integrate with almost every other software out there.
Bookkeeping software alone runs $35-60 a month. If you outsource bookkeeping, you may be looking at $300-$800+ a month for a bookkeeper.
Minimum annual cost $4,020 = $420 software + $3,600 bookkeeper.
5. Electing S Corp status from LLC or S Corporation formation
One time cost - $500 - $2,500
If you already have an LLC in place and are just electing S Corporation status, then your cost is going to be on the lower side. Starting an LLC or Corporation to elect S Corporation status will cost anywhere from $500-$2,500
Summary
As you can see, there are some baseline costs that S Corporations incur. Rarely does a company netting under $50k save enough in taxes to cover these costs.
That said, companies netting $75k - $100k generally do cover these costs and still provide tax savings to businesses.
Let's put it all together here with minimums:
$550 Payroll
$800 Tax Return
$420 Bookkeeping DIY
$500 Setup ____
$2,270 Minimum cost + State franchise fee
>>>To learn more about S Corporations and what is involved, download our free eBook called S Corp, Now What?
NOTE: Other rules apply to S Corporations like limitations on ownership that also must be considered. We also never recommend S Corp status for entities that own real estate.
