Dear Tax Talk,
I am a self-employed carpenter. I currently operate as a C corporation . I pay myself a salary, pay my health insurance, and put what is left in a SEP IRA. At the end of the year the corporation profit is near zero. Can a sub-chapter S corporation (S corp) or a limited liability company (LLC) save on taxes? I have no other employees.
— Tom
Dear Tom,
Each type of entity has its advantages and disadvantages. Without looking at actual numbers, it is impossible to tell which entity will save you taxes. An advantage of a C corporation without other employees is that you can set up a medical reimbursement plan.
Health insurance is usually deductible by an S corporation owner or an LLC member at some level, as is the health insurance of a C corporation owner. S corporation owners and LLC members can’t have a medical reimbursement plan similar to a flexible spending account in a cafeteria plan. However, a C corporation owner/employee can have his out-of-pocket medical expenses reimbursed tax-free.
Another advantage: A C corporation that is not a personal service corporation has graduated tax rates. A personal service corporation is an employee/owner-controlled corporation that generates its income from fees charged for services such as an attorney, accountant, doctor or consultant. Carpentry is not considered a personal service, as materials are an integral part of the service. In a C corporation , the first $50,000 in taxable income is taxed by Uncle Sam at 15 percent. This may be lower than the owner’s marginal tax rate, had the owner included the net income on their personal return such as in the case of an S corporation or LLC member.
A disadvantage of a C corporation is that, in order to draw out all the earnings, you have to pay employment taxes. This isn’t so much a concern if your salary is over the FICA cap of $97,500.
Another disadvantage is double taxation and lack of capital gains rates. A sale of appreciated property by a C corporation may result in half of the gain going to taxes at the corporate and shareholder levels, whereas the sale of appreciated property by an S corporation or LLC can result in as little as 15 percent in taxes.
In order to tell if the C corporation is a viable entity in the future, you should consult with a qualified CPA who can review your entire financial picture.
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.
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