How to Reduce Your FICA Taxes if You Own an S corporation
If you're an S corporation shareholder and work in the business, you are classified as an employee of the corporation (shareholder/employee) and treated the same way any non-shareholder employee is treated for income tax withholding purposes.
As an employee, your salary is subject to social security and Medicare taxes (FICA taxes). However, S corporation net profit is not subject to social security and Medicare taxes.
Therefore, if you pay yourself the lowest possible (and reasonable) salary, you would minimize your FICA tax obligation. S corporation net profit could be taken out of the business as a distribution by cutting a check to yourself. The net profit, whether distributed or undistributed, is subject to federal income taxes.
Make sure the salary you pay yourself is reasonable for the type of work you're doing. If the IRS deems your salary to be unreasonably low, part of your distributed (or undistributed) net profite could end up being deemed as wages, which would be subject to social security and Medicare taxes.
If you are a member (owner) of an LLC and had made an election on IRS Form 2553 to treat the LLC as an S corporation for tax purposes, and the election was approved by the IRS, you would be treated as an employee for federal tax purposes. If such an election was not made, you would be treated as a self-employed person for federal tax purposes.
Here's how this works:
Let's say your S corporation's annual gross revenues is $50,000. Total expenses are $40,000, which includes expenses of $15,000, plus your salary of $25,000. Net profit is $10,000, which you take as a distribution from the business..
The annual salary of $25,000 would be subject to social security and Medicare taxes of $3,825 (15.3% x $25,000, which includes the employer's and employees share of FICA taxes). The net profit distribution of $10,000 would be subject to federal income taxes and not social security and Medicare taxes.
Had you not taken a distribution of $10,000 and instead, taken $35,000 in profits ($50,000 minus expenses of $15,000) as compensation (i.e. salary of $25,000 plus a year-end bonus of $10,000), you would have paid and additional $1,530 in FICA taxes (15.3% x $10,000)
Note that the employer's share of FICA taxes (7.65%) is a deductible business expense.
- Return to the Tax Basics for Startups Table of Contents to find related links.