Option 3: S-Corp

By John Hazard  |  Print this article Print

Many VAR and reseller businesses start with an individual providing IT services to clients and getting paid and cashing a check. But just how that individual cashes the check will determine how much of the money he gets to keep come April 15. Here's a look at the best tax structures for VAR businesses.

3. S-Corp

An S corporation is an IRS declaration for corporation with few stakeholders. The primary difference between an S-corp and an LLC is that the business owner must pay themselves a salary from the company, which separates the business revenue from your personal income. It requires more maintenance than an LLC, but can come with significant tax advantages, said Sweeney. Unlike a C-Corp, the business does not pay a corporate tax.

"The biggest advantage of the S-corp is that it can reduce your self-employment tax," said Sweeney. "If you are a DBA or an LLC you are paying the [15.3 percent] self-employment tax on the entire revenue of the company. As an S-corp, you’re only paying the self-employment tax on what you pay yourself as an employee."

Berger offered this example.

A business owner operating as an LLC makes $100,000 in revenue (Assuming a 20 percent tax rate) That owner pays $20,000 in federal withholding taxes + $15,300 in self employment tax = $35,300

A business owner operating as an S-corp makes $100,000, but pays himself only $50,000 in salary. (Assuming a 20 percent tax rate).  That owner pays $20,000 in federal withholding taxes + $7,650 in self employment tax = $27,650.

(The other $50,000 may have gone back into the business or, can be paid to the business owner as a dividend, but self-employment tax won’t apply to it.)

Where business owners must be careful is to pay themselves a reasonable salary, said Sweeney. You can’t go from making $150,000 at XYZ corporation one year and then open your own business the next and say you only took a $20,000 salary while the business took in $130,000. They will catch that fast."

An S corp can be a good option for a business owner who knows there will be significant losses up front.

"Someone might say 'We’re gonna rely on my spouse’s salary for the first few years and we won’t take a salary from the business for a while.’" Berger said. "If that’s the case, then you probably want to separate your income from the business revenue with an S-Corp."

The disadvantage of the S-Corp is that it is more work and more expensive. As a corporation you are required to maintain a payroll -- regardless of how many employees you have -- and file quarterly financial reports.

"All that costs money and time," Berger said. "Is the tax savings worth it?"

The other disadvantage of the S-corp is that you are limited to 100 shares of a single class, so anyone trying to bring in investors or multiple partners can find it limiting.