S Corporations and low profits might not mix

Starting a consulting gig?

Ready to WASTE thousands of dollars by starting an S Corporation?

Wait, what? Aren’t S Corporations supposed to SAVE you money?

S Corporations have attained an unwarranted holy grail status in taxation among laypeople, even among some tax advisors. Here’s just one of MANY examples when having an S Corporation would be more expensive than NOT having an S Corporation:

You quit your W-2 job & picked up some 1099 consulting work toward the end of the year. Congrats! You have a business.

You’re the only owner of your new business and have no employees.

With everything you’re spending money on to get started, you expect expenses to be more than revenues this year. You expect to have a net LOSS.

You’re making decisions about the financial side of your business, including tax options. After hearing from friends that EVERYONE has an S Corporation, you decide you probably should have one, too. What could be the downside?

Quite a bit, actually.

First, the cost of running your business as an S Corporation. At the very least, it will need its own annual tax return, Form 1120S. I’ve rarely seen a business owner attempt to prepare this type of tax return. Instead nearly all of them delegate its preparation to an experienced tax advisor. Let’s say that fee starts in the $500-$2,000 range.

Additionally, once someone is operating their business as an S Corporation, they rarely prepare their OWN tax return anymore. So, potentially an extra expense here.

Lastly, S Corporations are typically expected to report a payroll of some sort to their owners, so possibly a third expense and administrative hoop here.

Now compare these costs to the tax savings to operating as an S Corporation.

S Corporations save federal SELF-EMPLOYMENT taxes. Self-employment taxes are calculated on self-employment income. Remember, you expect you’ll have a net LOSS this year. The tax benefit for you this year is…zero.

Could there be other compelling reasons to elect S Corporation status in your initial year? Absolutely! But is there a self-employment tax savings to be had? No.

👉S Corp cost - $500-$2,000 minimum tax return preparation.

👉S Corp benefit - $0 self-employment tax savings.

👍Verdict: Maybe wait and elect S Corporation status in a future year if profit levels make sense. Maybe elect S Corporation status for the current year for some compelling reason not involving self-employment tax savings.

Reminder: tax advice is specific to each person and your advisor will help you determine the best answer for you.