Quick Summary: Could Changing My Business Entity Mean Smarter Profits?
- If you’re a Sole Proprietor or single-member LLC, you’re likely paying a hefty 15.3% Self-Employment (SE) tax on 100% of your profit.
- Electing S-Corp status splits your income between salary (taxed) and owner’s distributions (not subject to SE tax).
- Acting now gives us time to analyze your numbers to see if the compliance costs are outweighed by the potential profit gain.
- An S-Corp also opens doors to retirement strategies, liability protection, and potential Qualified Business Income (QBI) optimization.
When you launched your Washington business, you probably picked your entity based on two factors: protecting personal assets and keeping the setup as straightforward as possible.
But as your profits increase, that original choice can go from advantage to burden… preventing you from maximizing your owner compensation structure.
And the smartest time to revisit your structure isn’t when you’re filing your return in April. It’s right now. So we have the time to analyze your numbers and map out a strategy.
Could changing your business entity mean you keep more of what you’ve earned? Let’s talk about it.
How does becoming an S-Corp save me money?
For a lot of small businesses, choosing S-Corporation status is a huge way to save.
Because you’re essentially splitting your business income into two buckets:
- W-2 salary: You must pay yourself a “reasonable compensation” through payroll. This portion is subject to payroll tax.
- Owner’s distribution: Whatever profit is left after salary flows through to you as a distribution (no self-employment tax on this portion).
Let’s look at some real-life numbers. Say your annual business profit is $150,000. Based on industry benchmarks, you set your salary at $70,000. The remaining $80,000 you take as an owner’s distribution.
As an S-Corp, you pay 15.3% SE tax only on your $70,000 salary ($10,710).
Compared to the $22,950 you would’ve paid as a Sole Proprietor, you could save $12,240 annually.
When is the best time to change my business entity type?
Timing this change right is critical. S-Corp status must be in place as of January 1st to cover the full tax year. The formal election is due by March 15th, but waiting until spring often means you’ve missed out on January–March savings.
Also, electing S-Corp status comes with some hefty payroll obligations, and your compensation strategy must be justifiable.
Which is why I would want to start using your clean, up-to-date profit reports in the fall so your tax professional can accurately model a reasonable salary.
And unlike a Sole Proprietor, an S-Corp is required to run payroll, withhold income and payroll taxes, and file quarterly payroll returns. You’ll need to establish and manage this mandatory payroll infrastructure to ensure compliance from day one, which is another reason October is the sweet spot for making the move.
Other strategic gains from reviewing your entity
On top of trimming the self-employment tax bill, switching to an S-Corp can also strengthen your DMV business’s long-term financial health. How?
- With an S-Corp, you can leverage plans like a Solo 401(k), often allowing bigger deductible contributions than a SEP IRA.
- The 20% Qualified Business Income deduction depends partly on wages. Having an S-Corp salary can actually help you maximize this benefit. Having a proper W-2 salary and accurate books ensures your tax professional has the data needed to maximize this benefit.
- If you’re still a Sole Proprietor, moving to an LLC or Corporation (before electing S-Corp status) adds a layer of legal separation between your personal and business assets.
FAQs
“How do I legally stop paying self-employment tax on all my profits?”
Elect S-Corp status. As a Sole Proprietor or single-member LLC, 100% of your profit gets hit with the 15.3% Self-Employment (SE) tax. An S-Corp lets you split your income into a salary (taxed) and an owner’s distribution, which is not subject to the 15.3% SE tax.
“How much profit do I need for S-Corp status to be worth it?”
Generally, when you consistently clear $60,000 to $80,000 in net profit. Below that, the cost and hassle of required payroll and compliance usually outweigh the tax savings. The higher your profit above that amount, the more substantial the benefit becomes.
“What is the deadline to set up an S-Corp to save taxes this year?”
To get the full year’s savings, the new status must be effective January 1st. While the final paperwork is due by March 15th, the smart move is to start the process in the fall. This allows time to set up your mandatory payroll system for a January 1st start and avoid missing out on early-year savings.
“How do I set my S-Corp salary?”
You must pay yourself a “reasonable compensation” W-2 salary. This amount must be comparable to what other companies pay someone for your exact role and duties in your industry and area. We can help you get the accurate profit data you’ll need to provide to your CPA, so they can run industry benchmarks to determine the recommended minimum salary.
“If I switch to an S-Corp, will I lose the liability protection of my LLC?”
No. S-Corp is just a tax classification you elect for your existing LLC. Your LLC structure continues to provide the same strong legal separation and liability protection between your personal and business assets.
“Does S-Corp status give me better retirement options?”
Yes, often significantly better. The mandatory W-2 salary in an S-Corp allows you to maximize contributions to higher-leverage retirement plans like a Solo 401(k), giving you bigger tax deductions now and better growth later compared to simpler plans like a SEP IRA.
“Will S-Corp paperwork and payroll be a giant headache?”
The compliance level goes up, but your time commitment doesn’t have to. The additional work (running payroll, quarterly filings) shifts from you personally to your tax professional and a dedicated payroll service.
If you aren’t sure what changing your business entity means in terms of real savings, let’s analyze your current profitability to see if the compliance overhead is justified.
And starting now gives us the time to get everything in place… like providing accurate reporting for your tax professional to determine a reasonable salary, establishing mandated payroll systems, setting up quarterly compliance reporting, all the fun stuff.
So, grab a time on my calendar. Let’s review your business entity type together:
calendly.com/cfosg_growth/sales-consultation
Looking backward to move you forward,
Manny Cosme