What is an S-Corp and how does it save you money?
Super short answer: You pay up to 15.3% less in FICA taxes on a portion of your income. Keep reading if you want to learn more about the taxes you currently pay and why you may choose to be an S-Corp someday.
An S-Corporation (S-Corp), more formally known as a Subchapter S Corporation, is a tax filing method available to some business entities, like Limited Liability Corporations (LLCs).
You may have arrived here from my post about Business Types to Know for the Practice Management Exam. That’s cool if you want to learn more about S-Corp taxes, but everything I’m about to cover is way beyond the scope of what’s on the ARE 5.0 exams.
Keep in mind, I am an architect, not a CPA. In fact, I hired a CPA to do my taxes.
Tax Basics
Before we understand how an S-Corp can save you taxes, you have to understand what taxes you currently pay. Let’s take a look at employee vs Sole-Proprietor taxes. Just remember 7.65%!
Employee Taxes
When you are an employee, every paycheck has some taxes withheld. The three main ones are Federal Income Tax, Social Security and Medicaid.
Federal income tax withholding will be based on the withholdings and exemptions you claimed on your W9. Not important for this discussion. If you end up getting a refund at the end of the year it means that too much was withheld, so you get the money back.
Social Security and Medicaid are separate line items, but together they are known as FICA, from the Federal Insurance Contributions Act. Together, they are taxed at 7.65% of your salary, with a catch…
Sole Proprietor Taxes aka Self-Employment Tax Penalty
When you operate a business as a Sole Proprietor you still pay Federal Income Tax, same as if you are an employee at a company. Only difference here is that you are supposed to pay your income tax quarterly. Also not important for this discussion.
The big difference is in the FICA. As an employee you paid 7.65% of your salary to FICA, but that tax is actually 15.3% and your employer paid the other 7.65% for you. When you are self-employed you owe BOTH halves of FICA, so you’re on the hook for that other 7.65% That can end up being a pretty big amount.
S-Corp Tax Savings
When you elect to file taxes as an S-Corp you split up your income between a Salary and a Distribution in order to reduce the amount of FICA you have to pay.
You must pay yourself a “reasonable” salary but it doesn’t have to be ALL your earnings. So you have a salary from which you pay Federal Income Tax and FICA and then a Distribution, from which you only pay Federal Income Tax.
If your profit as a Sole Prop is $100,000 you’d owe $15,300 in FICA and then income tax on $92,350 before your standard or itemized deductions. Note that you can deduct the “business” 7.65% portion of the FICA before paying income tax…I think. Pretty sure on that one.
If you elect to become an S-Corp you could pay yourself a salary of $60,000. You would pay income tax and FICA (both halves) on the $60K and then take a $40,000 distribution, from which you only pay income tax. In this example you save 15.3% on the $40,000, which is $6,120. You save more by reducing your salary and increasing the distribution, which is why you have to pay yourself a reasonable salary and not a $1 salary and $99,999 distribution. Best to consult with a CPA as to how much you can lower your salary and still have it be considered reasonable.
S Corp vs Sole Prop Tax Example
Here's a super-simplified breakdown of the taxes you might pay as a Sole Proprietor as compared with an S-Corp.
- This is $60,000 * 0.153. In actuality the two portions of 7.65% come from the employee (you) and the employer (also you, read S-Corp Issues below). But ultimately it's coming out of your pocket one way or another, so I included the full amount here.
- Your entire $100,000 profit is taxable. As a Sole Prop you are allowed to deduct the half of the 15.3% FICA, so your taxable income is $92,350. Even though you only have $84,700 left in your pocket, the employee 7.65% is taxed twice. I am pretty sure it works the same for the S-Corp taxes, as that $60,000 will be taxed on the W2 you issue to yourself with 7.65% coming from you as an employee and 7.65% coming from you as the employer. This is where I get a bit confused, which is why you shouldn't use an architecture blog as your tax guide.
- This is the approximate Federal income tax due. Tax rates increase in proportion to the income, but you don't pay the highest rate on all your income. That's the difference between your effective tax rate (income tax / gross pay) and your marginal tax rate (the highest rate you pay on a portion of your income) See the 2025 Marginal Tax Rates. In 2025 you pay 10% up to $11,925 then 12% up to $48,475 then 22% for incomes up to $103,350. In our example, only about $29,000 was taxed at 22%.
Then the question becomes, does the $6,120 savings make all the extra stuff you have to do worth it. What extra stuff? Well, becoming an S-Corp has some issues…
S-Corp Issues
Filing as an S-Corp is not as easy as filling out a different form and paying fewer taxes.
First of all, S-Corp is not an option for Sole Proprietors, so you have to become an LLC. Lots of architects do this anyway for the perceived liability protections of your personal assets, but I know plenty of architects who have remained Sole-Proprietors.
There are some startup costs to starting an LLC, though I think the process is generally considered easy and affordable. Once your LLC is formed you may have to pay annual personal property taxes or other business fees. Not difficult, not too expensive, but one more thing to keep track of.
BUT IT GETS BETTER!
To realize the tax savings of an S-Corp you need to have Owners and Employees. The Owner to receive a distribution and the employee to receive a salary. As a single-member LLC I am now the Owner of Ben Norkin Architecture and an employee of Ben Norkin Architecture. So now I have to pay myself a regular salary via a regular paycheck. This means I need a payroll service, which is maybe $75/month. It could be less, but now that I need it for the paycheck I also use it to pay any of my 1099s. Again, not prohibitively expensive, but it is more cost and more things to keep track of. And I need to make sure there's enough in my account every month to pay my own paycheck!
Then there are MORE taxes. As a sole proprietor or even as a single-member LLC in Maryland I would not owe unemployment tax. But now I have employees and I do. Unemployment tax rate is between 2.6% and 7.5%, though only up to the first $8,500 of salary. So it’s not something I pay the entire year, but it does eat into those FICA savings a bit.
And finally, my taxes are more complicated AND I have to file a federal business return, so I hired a CPA to do it for me. That's the biggest single cost here. And yeah maybe I could figure out my own taxes, but it would take me a lot of time and effort that could be better spent designing houses or trying to find clients or working on Hyperfine. Note that S-Corps don’t pay Federal business taxes, you just have to submit a filing showing your income, which then gets reported on your personal filing.