Introduction
Self-employment tax can be a big burden for business owners. It includes both Social Security and Medicare taxes, which are usually paid by employees and employers. However, S Corporation (S Corp) owners have a way to save on these taxes. This article explains how S Corp owners save on self-employment tax, diving into the technical details but using simple language to make it easy to understand. If you’re an S Corp owner, or thinking about becoming one, this article will show you how this strategy works in 2025.
What is Self-Employment Tax?
Before we dive into how S Corp owners save on self-employment tax, it’s important to understand what self-employment tax is. In the U.S., when you work for someone else, your employer pays part of your Social Security and Medicare taxes. As a self-employed person, you are responsible for paying both parts. This is called the self-employment tax.
The self-employment tax rate is 15.3%. It is made up of two parts:
- 12.4% for Social Security (up to a certain income limit)
- 2.9% for Medicare (with no income limit)
For business owners who are sole proprietors or partners in a partnership, these taxes can add up quickly. But for S Corp owners, there’s a way to reduce this tax burden.
How S Corps Save on Self-Employment Tax
One of the biggest benefits of choosing to run your business as an S Corporation is the ability to reduce the amount you pay in self-employment tax. Here’s how it works:
1. S Corps Are Not Subject to Self-Employment Tax on All Income
Unlike sole proprietors or LLC owners who pay self-employment tax on their entire income, S Corp owners only pay self-employment tax on their salary. Any remaining income, called distributions, is not subject to self-employment tax.
Let’s break this down with an example.
- Suppose your S Corp earns $200,000 in profit in 2025.
- You decide to pay yourself a reasonable salary of $100,000.
- That $100,000 salary is subject to self-employment tax (Social Security and Medicare taxes).
- The remaining $100,000 in profits can be distributed to you as a dividend. These distributions are not subject to self-employment tax.
By only paying self-employment tax on your salary (and not on the full $200,000), you save money.
2. The Role of Reasonable Salary
The IRS requires that S Corp owners pay themselves a “reasonable salary” for the work they do. This means you can’t just take a tiny salary and pocket the rest of the money as distributions to avoid paying self-employment tax. The salary you pay yourself should be comparable to what someone in your industry would earn for similar work.
How much you decide to pay yourself is a critical decision. If your salary is too low, the IRS may audit your S Corp and argue that you are not paying yourself enough. If this happens, you could face penalties or back taxes.
It’s important to consult with a tax professional to determine what a reasonable salary looks like in your specific situation.
More Ways S Corp Owners Save on Taxes
Besides reducing self-employment tax, S Corp owners have other advantages when it comes to taxes. Let’s look at a few additional benefits:
1. Pass-Through Taxation
One major benefit of an S Corp is pass-through taxation. This means that the corporation itself doesn’t pay taxes on its income. Instead, the income “passes through” to the owners, who report it on their personal tax returns. This avoids the double taxation that C Corporations face, where the company is taxed on its profits, and then shareholders are taxed again when they receive dividends.
2. Avoiding FICA Taxes on Distributions
FICA stands for Federal Insurance Contributions Act, and it includes Social Security and Medicare taxes. As an S Corp owner, you can avoid paying FICA taxes on the profits of the business that are distributed to you as dividends. However, you will still pay regular income tax on these distributions, but not the self-employment portion.
The Drawbacks of Being an S Corp
While there are many benefits to being an S Corporation, there are also a few drawbacks to consider. Here are a couple of things you should know:
1. Administrative Requirements
Running an S Corp comes with more paperwork than a sole proprietorship or an LLC. S Corps must file an annual tax return (Form 1120S) and keep detailed records of salaries and distributions. This means you may need to hire an accountant or tax professional to make sure everything is done correctly.
2. Reasonable Salary Challenge
As mentioned earlier, the IRS has strict rules about what qualifies as a reasonable salary. If your salary is too low, the IRS could reclassify distributions as salary and make you pay self-employment taxes on it. This can lead to unexpected taxes, penalties, and interest. Therefore, it’s essential to stay in compliance with these rules.
How S Corp Owners Can Maximize Their Savings
To get the most benefit from your S Corp, here are a few tips:
1. Keep Good Records
Good record-keeping is key to making sure your S Corp is running smoothly and that you are paying the right amount of taxes. This includes tracking your salary, distributions, and any business expenses. Accurate records help you avoid issues with the IRS and ensure you don’t miss out on tax savings.
2. Consult a Tax Professional
Given the complexity of self-employment tax laws and the need for a reasonable salary, it’s a good idea to consult a tax professional or accountant. They can help you navigate the rules and ensure you’re maximizing your tax savings.
Conclusion: How S Corp Owners Save on Self-Employment Tax in 2025
In 2025, S Corps continue to be a great option for business owners who want to save on self-employment tax. By paying yourself a reasonable salary and taking the rest of your income as distributions, you can reduce the amount you owe in self-employment taxes. Remember, though, that it’s important to stay in compliance with IRS rules and consult a tax professional to make sure you’re doing everything correctly.
If you’re considering setting up an S Corporation, or already have one, the ability to save on self-employment tax can be a significant benefit. However, be sure to follow the guidelines carefully, and enjoy the tax savings that come with being an S Corp owner!
