WHAT IS AN S CORP?
THE TAX BASICS
Taxpayers pay two different types of taxes on their income – income tax and payroll tax. While schools, roads, bridges, parks, and police/fire/EMS, and all the good things that you usually associate with taxes are generally paid for by property or sales tax, income taxes mainly pay for federal and state politicians to waste and maintain 90% incumbency rates, but I digress. In addition to your income tax, you also pay for Social Security and Medicare.
These taxes are taken directly out of your paycheck if you are a W2 employee at a fixed rate, separate from your income tax. They are also referred to as FICA taxes, or if you are 1099 or self-employed, self-employment taxes. As a W2 employee, about 7.5% of your wages are withheld as payroll tax up to a certain amount, and your employer pays another 7.5% (which you don’t see – your employer pays it behind the scenes, so to speak). If you are 1099/self-employed, you pay the entire payroll tax, both the employer and employee portions. So, taxes for 1099 physicians are a little higher up front than for W2 employees. Here’s where the S Corporation comes into play.
While LLCs filing as sole proprietors do not offer any tax benefits, electing to be treated as an S Corporation (S Corp) allows for savings on the self-employment tax. Note that S Corps are not entities, but rather tax designations – you must have an LLC/PLLC/PC/PA to elect to be taxed as an S Corp. Also note that S Corps do not offer income tax savings, but rather payroll/self-employment tax savings. As an S Corp, you are essentially treating yourself like an employee of your company. Your S Corp must pay you a reasonable salary as a W2 wage. The difference between what you earn as a 1099 (your company’s Gross revenue) and what your company pays you (your reasonable salary) is treated as a business distribution and is not subject to payroll tax. In this manner, S Corps usually save the average physician $5-10k per year in payroll tax, though this varies depending on income level.
Whereas sole proprietors pay taxes as estimated tax payments directly to the federal and state governments, employers pay taxes as “Withholdings.” To make a tax payment this way, you first must have Federal and State employer Withholding accounts, and whenever the company pays you a salary, you must calculate the payroll tax on the salary and pay any anticipated Federal or State tax owed as withholdings through the employer Withholding accounts. In addition, S Corps and other employers must file quarterly reports with the federal and state governments, such as Forms 941 and 940. This is what payroll companies do – they calculate and pay payroll tax, withhold and pay Federal and State taxes, file various required reports throughout the year, and deliver funds to employees as direct deposits or paper checks. 1099 Tax Doctor clients typically draw an annual salary from their company, allowing the bulk of taxes to be paid as a single payment near year end, and also provides all payroll-related services, so you do not need a separate payroll company for your S Corp.