At Ellrich, Neal, Smith & Stohlman, P.A., we deal with a variety of self-employed individuals. We often hear them talk about the tax deductions available for a corporation as opposed to a sole proprietorship.
First of all, any deductions you can take on a corporate tax return are available on your Form 1040, Schedule C as a sole proprietor. Internal Revenue Code Section 162 is the primary governing section on business deductions. The plain language of this section does not differentiate between a corporation and a sole proprietorship. The Code states that any deduction must be ordinary and necessary in carrying on a trade or business. The confusion may be a result of how social security taxes are paid under each scenario.
As a sole proprietor, you pay 15.3% of your self-employed net profit. This amount is primarily a contribution to Social Security. Operating as a corporation, you are required to pay the same Social Security tax on your compensation. However, you pay half personally and your corporation pays the other half. This is accomplished through withholding and the payroll tax deposit system.
Some people attempt to minimize payroll taxes when operating as an S Corporation by simply reducing their pay. They take their compensation as a distribution. The IRS is wise to this and, upon audit, will assess the payroll taxes they believe would be due on a “reasonable” salary. Therefore, if you don’t get caught, operating as an S Corp may allow you to avoid some amount of Social Security tax. We certainly don’t recommend this strategy. Interest, penalties, and the IRS’ ability to go back several years make the potential price too high.
With decades of experience in tax and accounting, Ellrich, Neal, Smith & Stohlman, P.A. is happy to answer any of your questions regarding taxes, forensic accounting, valuations, wealth management, and more. Contact our Orlando, Miami, or Palm Beach Gardens offices today to speak with a tax expert.