Last week I explained how self-employment taxes and payroll taxes are two sides of the same coin. This week, I will illustrate how a self-employed individual can benefit from being on payroll.
Let's take a closer look at how payroll can reduce excessive taxation:
1. Assuming no other data, $100,000 of business income for a self-employed individual (filing single in 2015) will result in $30,580 of tax.
2. Of this $30,580 in taxes, nearly half ($14,130) is in the form of self-employment tax.
3. If the business is an LLC, and if the LLC's member makes a timely "S" election for the tax year in question, AND the member takes 50% of the business's income through payroll, then the taxes owed with the individual's tax return will be only $17,263 (wheres before the amount was $30,580, suggesting tax savings of $13,317.
4. However, the taxpayer will have paid $7,650 in payroll taxes as the employee and employer of the S Corporation, so the 'true' tax savings are $5,667 (not too shabby!):
The 'S Corp' savings model does require the filing of a separate business tax return for the S corporation.
This model of tax savings does not always 'fit' a taxpayer's situation. Generally, however, this structure is ideal for service-based businesses such as medical, legal, and consulting practices.
Another benefit of payroll for otherwise self-employed individuals is the retroactive application of federal income tax withholding through payroll. That is, income taxes withheld from payroll are treated as being paid to the IRS evenly throughout the year, regardless of when the taxes are actually withheld. On the other side of the equation, self-employed individuals making estimated quarterly tax payments receive credit for a payment on the date it was received.
So if a self-employed individual owes $10,000 in taxes, the IRS will penalize that individual if the $10,000 is not paid early or evenly throughout the year. If this individual waits until January 15, 2017 to make a $10,000 estimated tax payment (which is to cover taxes for all of 2016), then there will be an underpayment penalty.
However, if that same individual waits until January 2017 to run a payroll bonus that includes $10,000 of federal income tax withholding, then the IRS treats that $10,000 as having been paid in evenly throughout the year.
For more on this topic, stay tuned for next week's tax blog. I will address "safe harbor" thresholds for high-income taxpayers and explain how payroll can help meet "safe harbor."
Calc you later!