Robin -- I have a new, unrelated question: I have an

Hi,
Self employed individuals, which means something very specific to IRS (sole proprietor, partners, LLC not electing to be taxed as a C-Corp or an S-Corp) always have the same amount of self employment tax (both the employee and employer side of social security and medicare, 15.3% on their share of
profit).
Those are the individuals that have a schedule SE ... and have to pay into the social security and medicare system, that way, (both the 1/2 that an employee has withheld from his paycheck AND the 1/2 that the employer would have paid for them).
The only other two possibilities for someone actively engaged in the business is to be an S-Corp or a C-Corp and take a salary. A SALARY (for the C-Corp and the S-Corp) is REQUIRED for owners that are involved in the operation of the business (You'll see why in a minute).
(Self Employed individuals don't take a salary. Their profit is their pay) ... OR they are just removing basis that they originally contributed.
Generally speaking, only REAL/FUNDAMENTAL tax savings, that comes from changing to a different type of entity, comes when moving from self-employed to being an S-Corp shareholder employee ...
... BUT this only happens when profits are so high that you've paid your S-Corp Expenses, paid yourself a reasonable salary (and this is the important part) and after that salary... still have LOTS of profit above that.
Why?
First lets address why the C-Corp doesn't usually, all other things being equal, generate tax savings.
C-Corporations generate DOUBLE taxation. Yes, the salary you pay yourself is a deduction for the Corp ... but a C-Corp is a separate taxable entity ... the ONLY business entity that pays it's OWN income taxes, at C-Corp rates.
Then if an owner wants to pull out profits, the C-Corp provides a 1099-Div and the owner (after his C-Corp has already had to give some of that year's profits to pay it's own taxes) is taxed again as it's passed out to him as a dividend.
... double taxation.
In CERTAIN situations it can still make sense, but for a private, closely held business this means that the owner is being taxed on that profit twice UNLESS it's retain the company.
The S-Corp, however, although not technically a "self-employment" vehicle DOES NOT pay it's own income taxes - just like the other TRULY self employed entities.
The 1120-S has a K-1, where profits in excess of expenses and salaries are passed directly TO the owners, and taxed on their 1040's. (Where the C-COrp has it's own 1120 tax return - NOT 1120-S like the S-Corp - and has to send in a tax payment based on that 1120.
SO here's the point ... An S-Corp and the self employment entities are just the same (although, as you mention, more paperwork and administrative overhead for the S-Corp) when it comes to medicare and social security UNTIL you get to a point of profitability in the S-Corp where there's profit left over AFTER paying your business expenses including your own salary.
Why?
With the self employed entities you pay 15.3% self employment tax on your profit.
With the S-Corp, you withhold 1/2 of that from the W-2 you must give yourself and the S-Corp (YOU) pay the other half.
THIS is WHY IRS requires that you pay yourself a reasonable salary ... so that you are paying what amounts to self employment taxes (both halves of the social security and medicare) ON that salary ... between your w-2 withholding and the other half that you pay AS the S-Corp.
SO, as you can see ... mathematically, all other things being equal, you only start saving on taxes (and it's only on SS & Medicare, 15.3% of profits) when the profit for your S-Corp gets WELL above what it takes to pay yourself that required salary and your other business expenses.
Because on that K-1 distribution of profits (over and above the salary and other S-Corp expenses) there NEITHER half of SS & medicare charged on that. It's a pure dividend. ANd unlike the dividend from the C-Corp, it hasn't ALREADY been taxed once.
SO, to recap. Self employees can't have salaries (you can call them that, but what you're really doing is pulling out your profits OR something you've already invested OR borrowing money somewhere).
Corporations MUST pay a salary, if you're involved in the business, so you and (and your employee, you) are paying social security and medicare on THAT.
In the C-Corp, dividends above and beyond that are taxed again to owners through the 1099-DIV.
But in the S-Corp, dividends (technically called distributive share of profits) above and beyond your salary and other expenses, do not carry a social security and medicare burden, AND are not taxable TO the S-Corp... ONLY you.
Last point, the temptation then, is to pay yourself a REALLY small salary and take most of the profits through the 1120-S K-1. THis has been the most audited and litigated issue in small business tax, in my opinion. IRS is all over this one.
SO that brings us back to that original point. The break even analysis you have to do to move from truly self-employed to S-Corp owner looks like this:
IS the 15.3% savings on that excess profit (over and above a reasonable salary and other expenses) enough to offset the expense of having someone do payroll, quarterly payroll tax returns, pay-ins to social security at least monthly, etc., etc.
Lets say that you're worth 50,000 for what you do.
And that your gross is 100,000.
ANd that your other expenses are 25,000.
You'll pay both halves of the social security and medicare on your salary of 50,000.
the 25,000 that there in other costs are deductible
But that leaves you with 25,000 that will pass through without that 15.3% burden, (25,000 x .153) = 3825
Is that 3825 more than what you'd pay to a firm to do the payroll and payroll tax processing? (not to mention the additional risk of getting things paid-in, etc)
If not, keep the LLC/Sole Prop/Partnership ... same net SE costs (unless your underpaying your salary on the S-Corp side, and that's an audit risk) without all the headaches.
Hope this helps
lane