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3 Ways S Corp Owners Avoid Self-Employment Tax. . --  Kiritsis Law Firm Group 212 922 0005

Apr 27, 2021

One of the main tax benefits, of S Corp elections, is the potential self-employment tax savings.

 1. Shareholder vs Employee Classification. Employees, who own their own business, are subject to paying self-employment taxes. By putting the business into a corporation that elects S Corp tax status, it is possible for those owners to shift a portion of the business ‘taxable profits to being passed on to them as capital distribution (i.e. return of capital, or income generated by merely asset ownership rather than owner providing services. Doing this legal maneuver could reduce to owners paying less salary for them, which should make their self-employment taxes go down.

2. Return of capital income structuring.  This basically reduces your income, by essentially ballooning the business' balance sheet, and then dispense of the additional cash, which at worst receive capital gain tax treatment (generally, a far better tax rate than individual shareholder employees), and reduce the amount paid to owners as salary, hence, resulting into a lower tax bill. For example, the S Corp build up its assets (in large part by paying smaller salaries), by investing in certain stocks in the stock market, and then turning around after some period of time, to sell them, with receipts of the sale, passing to shareholders as distribution, and NOT as salary.

3. Using subsidiaries to reduce overall taxable income. This gets more complicated, and it is usually for S Corp shareholders that own significant assets, either as individuals or as part of business operations. For example, let's say you own a property that generates losses (partly, because it is occupied by you or family members) and happens to have so empty storage, while, you also, own a restaurant that leases its business space.  You can put the house and business operations in an S Corp, then set up a subsidiary, which owns all the restaurant equipment. The S Corp subsidiary gets paid rent from the S Corp. Looking at the big picture; many of the previously unused losses have been absorbed by the restaurant businesses. Also, some of the restaurant provides, that would otherwise, had been used to pay owners salaries. Obviously, there must be economic substance behind those transactions to hold against a tax audit, this is often, rarely an issue with the properly drafted legal documents and substantiation records.  This process described in this example, regarded as transfer pricing, with a long of possible tax savings, often comes with other advantages, such as more useful accounting reports that can help management run the business, better ways to track employee performance, and less shrinkage from employee theft.

 

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