A small business owner can calculate their tax savings when switching from a Schedule C (sole proprietorship) to an S corporation by considering the reduction in self-employment taxes and potential corporate tax benefits. Here's a step-by-step breakdown:
Step 1: Calculate Your Current Self-Employment Tax (Schedule C)
As a sole proprietor, you pay self-employment tax (Social Security & Medicare) on your net business income.
- Formula: Self-Employment Tax= Net Business Income × 15.3%
- Example: If you earn $100,000 in net profit: 100,000 × 15.3% = 15,300. Your self-employment tax would be $15,300.
Step 2: Determine a "Reasonable Salary" for the S Corp
The IRS requires S corporation owners to take a reasonable salary before taking profit distributions. Use our reasonable compensation calculator to calculate your salary.
Step 3: Calculate Payroll Taxes on the Salary
As an S corporation owner, your salary is subject to FICA taxes (Social Security & Medicare), but not your distributions.
- FICA Tax Formula: Salary × 15.3%
- Example: If you pay yourself $60,000 in salary: 60,000 × 15.3% = 9,180. Your payroll taxes on this salary are $9,180.
Step 4: Calculate Tax Savings on Distributions
The remaining profit can be taken as distributions, which are not subject to self-employment taxes.
- Distributions Calculation:
Total Profit−Salary=Distributions - Example:
100,000 − 60,000 = 40,000
The $40,000 in distributions is not subject to payroll taxes. - Self-Employment Tax Savings Formula:
Distributions × 15.3% - Example:
40,000 × 15.3% = 6,120
You save $6,120 in self-employment taxes by switching to an S corporation.
Step 5: Factor in Additional Costs & Considerations
While tax savings are significant, also consider:
✅ Payroll Costs (payroll provider fees, bookkeeping)
✅ State S Corporation Taxes (some states impose franchise taxes or fees)
✅ Corporate Formalities (maintaining corporate compliance and filings)
Final Tax Savings Summary
💡 Potential Annual Tax Savings: $6,120+ (varies based on income and deductions).
Sources:
- IRS Self-Employment Tax Guide
- IRS S Corporation Guidelines
- S Corp vs Sole Proprietor Tax Comparison - Collective
