In this transcript from a video by Steven J Wick & Associates PC, Steve Wick explains the key tax differences between a sole proprietorship and an S corporation, including self-employment tax, payroll requirements, retirement plan considerations, and profit distributions. A major focus of the discussion is When to switch to S corporation status and how income thresholds, reasonable salary rules, and compliance costs impact that decision. The video walks through real-world examples to demonstrate potential tax savings and the additional administrative responsibilities that come with an S corporation election.

To learn more about the tax differences and benefits between a sole proprietorship vs S corporation, check out our detailed article on when to switch to an S corporation in Fort Collins.

This video is presented by Steve Wick of Steven J Wick & Associates PC in Fort Collins for informational purposes only; it does not constitute legal or tax advice, and we recommend contacting a qualified CPA regarding your specific situation.

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[Music] from an income tax standpoint sole proprietorships they’re the easiest one of the bunch because a they’re easy and and b there’s certain taxing things that can come out of it the the problem is is sole proprietorships have this nasty thing called self-employment tax which is basically social security and medicare tax that everybody pays when they they have a job they pay into those funds generally it’s 7.65 from the employee and then there’s an employee match of 7.65

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also in total is 15.3 percent just a nice round number is 15 and so that tax can add up really quickly for people and oftentimes i’ve seen over the years where the self-employment tax also known as se tax is higher than a person’s income tax on their returns depending on how everything else shakes out so it’s something that we watch extensively [Music] various things so one of the things is the home office deduction home office deduction within an escort is much more difficult to get than a sole

00:01:38

proprietorship one of the areas another area is in the retirement plan area because all dollars within a sole proprietorship are considered self-employment taxed income then potentially more dollars are available to you for the various retirement pieces that are out there sep iras or se self-employed persons iras and the percentages that go into that there’s simple plans there’s 401ks all of those things can need to be looked at when you do it but all in all i’m just kind of cut to the

00:02:19

chase personally i don’t really consider switching from a sole proprietorship to like an s corporation until they get that 22 to 25 000 of income range in a year because there is some additional costs to an s corporation there is an additional income tax return that needs to be done so there’s that cost and then there’s quarterly payroll tax returns that must be filed for the business now when you elect as corporation status you automatically become an employee of your business that

00:02:56

requires you to have aw2 payroll taxes a payroll amount that you’re paying yourself that payroll is supposed to be effectively what would it cost you pay for somebody else to do your job so for example let’s say you unfortunately become injured or disabled or something so you have to go pay somebody else to come do a job to keep your business going what would that be that’s that’s what the definition kind of is so we kind of target that but you can’t just say i’m going to pay myself a dollar and take

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everything else and distributions you have to pay yourself a fair wage [Music] you’re a business owner slight definition change but like for myself i’m an s corporation and you know it’s kind of a me and myself and i type thing so yes i’m self-employed in one sense but from a taxability sense there are changes if it’s just you like i said that’s the it’s the question are you if you’re gonna make more than 20 25 000 then it will be a significant change so i have an

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example so let’s just say for simplicity purposes a business makes in total before paying any wages to the owner a hundred thousand dollars straight because of the self-employment tax that’s fifteen point three percent or that’s fifteen thousand three hundred dollars in self-employment taxes that will need to be paid on all the income of the business straight and then in addition to that you’ve got income taxes to be paid from the s corporation you still have a hundred thousand dollars

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now the s corporation does not pay any income tax it has a 1120s form that it makes and is filed with the irs a k1 is generated for the individual i compare k1 to a bank that sends you the individual a 1099 interest on the savings account that you have so if you have ten thousand dollars in the savings account you’ve made a hundred bucks on an interest in the year obviously the bank’s not paying any income tax on that money it sends you a form you report that hundred dollars on your personal income tax return and it’s

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yours whether you take the money out of the savings account or not you still pay income tax on that money you now have rights to that ten thousand one hundred dollars you could take that out at any point in time whether you choose to or not is up to you same thing with an s corporation as a corporation it makes money and then you have rights to its profits whether you take that money out or not you as an individual are still going to have to pay income taxes on that money where it changes from a sole

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proprietorship again we said like the hundred thousand dollars let’s just say that we take half of that money in a wage so fifty thousand dollars that money is subject to fica and medicare tax or self-employment tax same number okay that’s seven thousand six hundred and fifty bucks is what that number is but then you have the additional fifty thousand dollars that’s sitting out there you’ll have to pay income tax in that additional fifty thousand dollars you just won’t have to pay tax on that

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money so by switching to the s corporation in this example you’re gonna save you know 7 500 bucks there are a few costs that go in into this so because you have wages you have unemployment taxes to pay in your wages both federal and state there is an additional tax return that has to be filed for the business and all those things so that is additional thing but i will guarantee you that you will save quite a bit of money by switching to s-corporation reason why i say the 25 000 of profit from a business is because

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below that it’s really hard to justify if you’re full-time you’re going to have to pay yourself a wage of 18 20 000 and so that little bit of difference five grand that’s left over and the savings of that you know fifteen percent of five thousand dollars is 750 bucks trust me in fees and other services and stuff that you have to do those that price will be eaten up quickly [Music] you

When to Switch to S Corporation

Understanding When to switch to S corporation status depends largely on profitability, compliance costs, and reasonable salary requirements. While an S corporation can significantly reduce self-employment tax once profits reach certain thresholds, it also introduces payroll obligations, additional tax filings, and administrative responsibilities. Business owners should carefully evaluate income levels—often around the $22,000 to $25,000 profit range or higher—before making the election. Because every business situation is different, consult a qualified CPA to determine the most tax-efficient structure for your specific circumstances.