In this episode: Death and taxes may be certain, but how much you pay in taxes isn’t fixed. Jon Peyton covers three levers business owners can use to manage their tax bill: how the business is structured, how you pay yourself, and which expenses you deduct. As he says on air, this is general education; work with your own CPA and attorney.
Key insights
- Your business structure (sole proprietorship, partnership, S corp or C corp) affects both legal protection and taxes, and it can change as you grow.
- S corps pass profits through to the owners. C corps pay corporate tax first, and distributed profits are taxed again at the personal level.
- C corps can make sense when a business keeps and reinvests a large share of its profits.
- How you split pay between a reasonable salary and distributions affects payroll taxes.
- Accelerated depreciation and tax-favored employee benefits can lower taxes while funding things the business needs.
Episode timeline
- 0:00 Business taxes: three levers
- 1:08 An important disclosure
- 1:54 Structure, pay and expenses
- 4:11 Sole proprietorships, partnerships and corporations
- 7:00 S corps versus C corps
- 11:19 When a C corp makes more sense
- 13:58 Asset-heavy versus service businesses
- 15:23 How you pay yourself
- 16:02 The reasonable salary requirement
- 19:14 When an S corp election starts to make sense
- 20:08 Expenses: depreciation
- 22:51 Section 179 accelerated depreciation
- 26:18 Structuring employee compensation
- 29:47 Benefits that aren’t subject to payroll tax
The episode in brief
Three levers. Jon frames business tax planning around your strategic plan: where you want to go and how fast. Within that, the levers are structure, how you’re paid and what you deduct.
Structure. The main options are a sole proprietorship (often a single-member LLC treated as a disregarded entity), a partnership, where owners receive K-1s, and a corporation, often an LLC that elects S corp or C corp tax treatment. You can change structures as you grow. Keep up the formalities, too, or you may lose the protections you set the entity up for.
S corp or C corp? An S corp passes profits through to the owners, taxed at their personal rates. A C corp pays corporate tax, 21% at the time of recording, and profits distributed later are taxed again at the personal level. That double taxation makes the S corp the more common choice. But when a business earns a lot and needs to keep much of it for equipment, vehicles or hiring, retaining earnings in a C corp can cost less overall than passing everything through at the top personal rates. In Jon’s experience, asset- and inventory-heavy businesses lean toward C corps as revenue grows, while service businesses often favor S corps.
How you pay yourself. The IRS expects owners to pay themselves a reasonable salary for their role, based on what similar positions earn. In an S corp, salary is subject to payroll taxes, while distributions generally aren’t, so finding the right balance can meaningfully lower your total tax bill. In Jon’s experience, the switch from a sole proprietorship to an S corp election often starts to make sense once net profit reaches roughly $75,000 to $100,000.
Expenses: depreciation. Business assets are generally deducted over time through depreciation. Section 179 and related rules can let you deduct certain qualifying purchases, such as equipment or some heavy business vehicles, much faster, subject to IRS rules and limits. Jon’s example: an owner who needs a qualifying vehicle anyway may lower this year’s tax bill while gaining an asset the business uses. The purchase still has to make business sense on its own.
Expenses: employee benefits. Payroll taxes add to the cost of every salary dollar. Employer-paid health insurance premiums generally aren’t subject to payroll taxes. By pairing a slightly lower salary with fully paid health premiums, an employer may offer a comparable or better total package at a similar cost, while saving on payroll tax. Employees may value the predictability of covered premiums.
Key action items
- Review your entity structure with your CPA. Ask whether your current structure still fits your profit level and reinvestment plans.
- Document a reasonable salary. Base it on comparable roles and keep the support on file.
- Plan major purchases with your CPA. Before year-end, ask how and when depreciation rules apply to equipment you actually need.
- Model total compensation, not just salary. Compare packages that shift some pay into tax-favored benefits.
Listen next: Episode 32: The IRS Lets Entrepreneurs Do This to Lower Their Personal Taxes
Value Creation Consultancy™ has since merged into Founder’s Accounting™.
Tax rules, rates and limits mentioned reflect the law at the time of recording in 2022 and may have changed since.
This episode is educational and isn’t legal, tax or financial advice. Speak with your own attorney and advisers about your situation.