The S election is generally thought of as a tool to achieve pass-through taxation of C corporation income and avoid the double tax.
Electing Subchapter S treatment may also be a beneficial strategy for many pass through entities because a portion of income will not incur employment taxes. In order to receive Subchapter S treatment, Form 2553 needs to be filed in a timely manner.
Social Security tax is assessed against all wages salary, tips and Schedule C income at a rate of 12.4%. It is only assessed on income up to the contribution base, $137,700 in 2020. Employers and employees each pay half of the tax.
Medicare Hospital Insurance Tax is assessed against all wages, salary, tips and Schedule C income at a rate of 2.9% with no cap. Employers and employees each pay half of the tax. There is an additional .9% Medicare Tax on income above certain limits.
The S election allows a business owner to save on employment taxes because earnings can be segregated between wages and distributions. Wages are subject to employment taxes, whereas distributions are not.
How earnings are allocated to each category is contentious and unclear. There are no specific guidelines for reasonable compensation.
Our team of professionals at KRD can help you determine appropriate compensation levels for Social Security taxes and retirement plan contribution levels. Contact us today to learn more.