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Sub Chapter S Taxes work like this : 

First off , when you incorporate initially with the state, the corporation is only recognized as a "Corporation" either General or Closed.  Sub S Status is an Election made by all the shareholders of the corporation and by the Board of Directors ( you can be both shareholder and director).  The Election has to be made with in a certain period of time from the official filing of your corporation with the Federal Government, and depending on the state you are incorporating in, the state division of Corporations or Revenue Division.  Sub Chapter S status is NOT AUTOMATIC WITH THE GOVERNMENT OR STATE.

To Qualify, All shareholders have to be a U.S. citizen or a Resident Alien.

O.K., How does it work?  As your company grows, revenues will begin to flow into the company, expenses will increase (not in all cases), and you have to determine what is going to happen with these monies that are left over.  Take a Salary ?  Take a Distribution ?  Reimburse yourself for business related expense ?   How about all of the above !  Yes , you can do all.  You can even pay your children and avoid that much more in taxes while skipping the Kiddie Tax !  It's unbelievable what you can do to REDUCE YOUR TAX LEGALLY !  

So then, how is this accomplished?  You may askRule #1  Pay yourself first.  What I mean by that is if you are able to reimburse expenses, such as gas you paid for, auto leases, meals, entertainment, lodging, office supplies (if you have school age kids...guess what....school supplies are now "office supplies"   Rule # 2  What ever you plan on taking out the day you pay yourself...record 1/2 as pay and 1/2 as a shareholders distribution.  You see what ever is left over as a profit at the end of the year is yours anyway.  This will make sense in a few seconds.   The reason you arrange your pay this way is that you avoid paying Social Security and Medicare Tax on the amount that is a distribution.  Take it one step further in numbers

Assume there was $50,000.00 left over after expenses from your year of hard work ( or the one contract that pays you ).  If you pay yourself $25,000 in wages and $25,000 in distribution this is what you saved :

$25,000 x 15.3 % (Social Security and Medicare Tax combined)

= $3825.00 in Tax Savings

Now Invest the money you just saved !  Smart..$$

$3825.00 invested into an IRA/401(k) or SEP  for a period of 20 years at a 10%  return... Tax Savings on this Only (without interest or growth) is $76,500 !  The Tax Savings Becomes a problem now...Just like paying too much tax...  Now you save even more, because the $3825.00 becomes DEDUCTIBLE ! It's just crazy that anyone would operate as a Sole Proprietor vs. a Sub S corporation !!

 

 

 

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