Tax Law (Questions About Taxes)/S-Corp intracacies
Started IT consulting as a S-corp last year (actual work started Dec2012, but first paycheck landed Jan 1 2013); Contract work ended Apr2013
--I filed an extension on Mar17 (actually Mar 18 because of the timing of the maildrop)
--since I did very brief review of what it meant to be S at the time I started, I think I screwed up: I didn't think quarterly estimates were needed (because everything goes on personal tax form), so what do I need to do now?
--MOST IMPORTANTLY: I grossed 83k on the contract, but since it only lasted ~4 months, do I divide a "fair salary" for what I do by 3? (1/3 of an annual salary) --this toward figuring out my estimate (tax extension) that flows through to my personal taxes
The bigger questions are:
Will you continue to do IT Consulting?
Will you continue to do it in your existing S-Corp?
Before we jump to a conclusion we should know the foundation upon which assumptions are based.
The claim is: "The S-Corp can provide a tax advantage". Does that mean we should do business as a S-Corp?
The correct answer is D, not enough information.
Let's analyze the "tax advantage". From your question I know you already understand some of this nuance. The S-Corp allows for a portion of the total taxable revenue of the business to passed to the owner without being subject to Self Employment tax.
The business makes, $200,000 Gross revenue, has $110,000 in deductible business expenses, leaving $90,000 as taxable revenue. Now for the "Some Portion" part. It would be nice to say 100% passes without payroll taxes. That would put an additional $13,770 in our pocket. Quite a savings. But, that isn't how it works.
WE first have to "EARN". Earn means payroll taxes. we have to earn a "reasonable" salary, thus your question about "Fair Salary". Reasonable salary is commensurate with industry standards, what would you have to pay someone to replace you in the business. Problem?. . .
You are working for the S-Corp even when there is no "Business Income". You are still the president, you are still the guy working to get another contract, etc. So an argument would be that the business would need to use its reserves generated in the first 4 months to provide payroll the rest of the year.
If you were going to claim anything different you need to be confident that you can justify it to an auditor that may not want to believe it. Don't expect your tax preparer to make that argument, you need to be the one that can make it.
83k gross means you had some business deductions throughout the entire year, so your net taxable should be less than that. Let's say it is $70,000. Under the full year income scenario all of that would be considered salary. The S-corp did you no good. So we are back to the question:
"The S-Corp can provide a tax advantage". Does that mean we should do business as a S-Corp?
In the above case the answer is no.
Let's choose an alternate scenario. That you could justify in your own mind that your time was not needed the rest of the year and therefore your income is not a homogenized annual income it is sporadic occasional income. And on one occasion in 2013 you were able to generate $83,000 in 4 months.
In that case, the S-Corp could reduce some tax. Does that mean we should do business as a S-Corp? Let's go further before we take that conclusionary leap.
Assume $30,000 for the 4 months was a reasonable salary that you could claim. There are more rules. Over the past 5 years or so, the IRS has codified the "Earned" "passive" ratio that they feel is reasonable. That almost always is 80% earned.
So you can take 20% passive. That same $70,000 times 20% is $14,000. You are trying to save social security and Medicare on $14,000. That is the savings the S-Corp can provide.
15.3% of $14,000 is $2142. That's it. Under the best of circumstances the S-Corp could reduce your taxes by $2,142.
You are still going to pay, your income taxes on $70,000, at your prevailing rate, you are still going to pay payroll taxes on the rest of the $70,000 at 15.3%. You didn't mention if you are married or single, if married does your spouse work. Filing jointly? Did you receive any other income during the year outside of the S-Corp? I'm just to give an estimate. If you are single or your spouse has other income that contributes to your family income and for the other 8 months you had income form a job. then these $70,000 would be attributed to you, at a rate of at least 25% Federal taxes, we know that $56,000 is subject to SE tax of 15.3% so $26068.00 goes to taxes federally and then you also didn't say which state you are in. State taxes are from zero to 12% average is 5%, you can calculate the taxes at that level. 26-34 thousand dollars in taxes and the S-Corp might have reduced it by 2 grand.
What if you hadn't filed the 2553 form that changed your real corporation to a subchapter S corporation?
If you had other income and you didn't really need the IT consulting income to sustain your lifestyle the real corporation might have retained all the money. If it kept all the $70,000 it would have paid federally 15% on the first $50,000 and 25% on the last $20,000. That would be $12,500, add in your state tax rate. . .
There is still $18,000 of money because the it was a real corporation.
If it was your only income, and you needed $50,000 of it to support yourself, then the other $20,000 still wouldn't have paid any SE taxes and wouldn't have been subject to your personal tax rates. NO SE taxes on $14,000, or no SE taxes on $20,000?
No personal income taxes on that $20,000, only lower corporate taxes?
Does that mean we should do business as a S-Corp?
What do you do now?
You have choices, call me.