How to Use Your Corporation to Save Taxes

How to Use Your Corporation to Save Taxes

First of all the name of the game is to have the corporation pay for as much as it possibly can so you are using pre-tax dollars. That means just what it sounds like, you are using money that you haven’t paid tax on yet. The corporation takes in income then gets to deduct all business related expenses and pays tax only on what’s left over, net taxable income.

C Corporation

If you have a C corporation, then the corporation will pay the tax on the net income. If you can leave some of the money in the corporation (as opposed to taking it out in the form of wages to you) this will save taxes because the corporation pays only 15 % federal tax on the first $ 50,000 of taxable income.

If the corporation makes $ 93,300 and if you can leave $ 50,000 in the corporation you will pay 15 % tax on all of the income, that is, the combined tax between you and the corporation. Here’s how:

Corporation net income $ 93,300
Less: wages to you ( 43,300)

Net taxable income to corporation $ 50,000 taxed at 15 %

Wages to you $ 43,300
Less: standard deduction
& personal exemption ( 9,350)

Taxable income to you $ 33,950 taxed at 15 %

So you’ve paid 15 % tax on $ 93,300 of income!

Remember, if you or you and your spouse are the sole owner/employees of the corporation it doesn’t matter who is paying the taxes you or the corporation. It’s all coming out of your pocket. For example, when you pay yourself wages the corporation will pay the FICA Social Security and Medicare taxes by withholding 50 % from wages and paying 50 % itself. It’s still all coming out of your pocket because you own the corporation.

S Corporation

If you have an S corporation, then the net taxable income and certain other items, like interest income and capital gains, will be passed through to you to be reported on your individual tax returns. If you can leave some of the money in the corporation (as opposed to taking it out in the form of wages to you) this will save taxes because the net income from an S corporation is not subject to self employment tax.

This is the great advantage to using an S corporation instead of a sole proprietorship that reports its income on your 1040 Schedule C. All of the income on the Schedule C is subject to self employment tax. It’s a killer!

Now keep in mind, you are an employee of the corporation and you must pay yourself a “reasonable” wage for the services you perform for the corporation. This means it can’t be too high or too low. If you are the sole owner/employee then no wage is too high because all of the income was generated by your efforts. Under the same theory, if you don’t pay yourself all of the income in the form of wages, the IRS may say you didn’t pay enough.

If you do not take all of the income out in the form of wages you should be careful about taking other distributions. Although you are allowed to take distributions from an S corporation without paying tax on them, the IRS could recharacterize the distributions as wages and charge you payroll taxes on them.

These are just a few areas where you can save money by using a corporation. If you have any questions about your tax strategy call Law Offices of Patricia Rowe at 925-256-1000.