Understanding how to budget for taxes is crucial for business owners, particularly those operating as a Single Member LLC or a 100% owner of an S-Corporation. Both structures offer distinct advantages and tax implications, so let’s break down the key differences and provide a straightforward approach to determining your tax budget.
Single Member LLC
A Single Member LLC is treated as a disregarded entity for federal tax purposes, meaning the IRS doesn’t recognize it as separate from its owner. Instead, all income and expenses are reported on the owner’s personal tax return using Schedule C. Here’s how to estimate your tax budget:
1. Estimate Your Net Income: Calculate your expected annual income minus business expenses to determine your net income.
2. Self-Employment Tax: As a Single Member LLC, you’re responsible for paying self-employment taxes, which cover Social Security and Medicare. This is approximately 15.3% of your net income.
3. Federal Income Tax: Determine your federal income tax rate based on your total taxable income, which includes your net income from the LLC. Federal tax rates vary by income bracket, so refer to the current IRS tax brackets.
4. State Taxes: Check your state’s tax requirements as these vary. Some states have flat rates, while others have progressive rates.
5. Estimated Tax Payments: Since taxes aren’t withheld from your income, you must make quarterly estimated tax payments. Use IRS Form 1040-ES to calculate these payments.
Example Calculation:
• Estimated net income: $100,000
• Self-employment tax: $100,000 x 15.3% = $15,300
• Federal income tax (assuming 22% bracket – aggregate rate of 14%): $100,000 x 14% = $14,000
• State taxes (assuming 6%): $100,000 x 6% = $6,000
• Total estimated tax: $15,300 + $14,000 + $6,000 = $35,300 or approx. 35%
Therefore, you should budget approximately $35,300 for taxes as a Single Member LLC.
100% Owner of an S-Corporation
An S-Corporation is a pass-through entity, meaning income, deductions, and credits pass through to the owner’s personal tax return. However, the key difference lies in how the income is categorized and taxed.
1. Reasonable Salary: As an owner, you must pay yourself a reasonable salary, which is subject to payroll taxes (Social Security and Medicare). This salary is deducted from the corporation’s income.
2. Distributions: Remaining profits can be taken as distributions, which are not subject to self-employment taxes but are subject to federal and state income taxes.
3. Federal Income Tax: Like a Single Member LLC, your total taxable income determines your federal tax rate.
4. State Taxes: Again, check your state’s tax laws as they apply to S-Corporations.
5. Payroll Taxes: Your salary will be subject to payroll taxes. The corporation is responsible for matching your Social Security and Medicare contributions.
Example Calculation:
• Estimated net income: $100,000
• Reasonable salary: $60,000
• Payroll taxes on salary: $60,000 x 15.3% = $9,180 (split between employee and employer, so $4,590 each)
• Remaining profit as distribution: $40,000
• Federal income tax on salary (assuming 22% bracket – aggregate rate of 14%): $60,000 x 14% = $8,400
• Federal income tax on distribution (assuming 24% bracket – aggregate rate of 14%): $40,000 x 14% = $5,600
• State taxes on salary and distribution (assuming 6%): $100,000 x 6% = $6,000
• Total estimated tax: $4,590 + $8,400 + $5,600 + $6,000 = $24,590 or approx. 25%
• Don’t forget that the other side of FICA ($4,590 paid by employer, represents a 4.6% tax as well – this is just paid for by your business and is a recorded as an operating expense).
So, you should budget approximately $24,590 for taxes as a 100% owner of an S-Corporation.
Adding in the Employers portion of the taxes – your all in tax rate should be about 30% in this example – illustrating that the tax savings would be approximate 5% or $5,000 by operating as an S-Corporation.
Conclusion
While the specific numbers will vary based on your income and state tax rates, these examples illustrate the basic approach to budgeting for taxes. A Single Member LLC generally faces higher self-employment taxes, while an S-Corporation can reduce overall tax liability through distributions. However, the S-Corporation requires careful adherence to reasonable salary guidelines and payroll tax obligations. For personalized advice, consulting with a tax professional is always recommended to ensure compliance and optimization of your tax strategy.
