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Writing is Taxing

 

 

Could Forming
an S Corporation
Save You Money?

One of the biggest surprises to my self-employed clients was the self-employment tax. While all were aware they’d owe income tax on their net earnings, they often did not realize they were also obligated to pay Social Security tax, a.k.a. “self-employment tax,” if their net earnings totaled $400 or more.

Social Security taxes are currently 15.3% of a taxpayer’s salary or net earnings from self-employment. This 15.3% includes two components — a 2.9% Medicare component and a 12.4% Old-Age, Survivors, and Disability Income (OASDI) component. While the Medicare component applies to unlimited amounts of income, the OASDI portion applies only to salary or net earnings up to the annual wage base limit, which is $113,700 for 2013.

You may have heard that you can save on Social Security taxes by forming an S corporation (“Small Business Corporation”) for your writing business. This savings is possible given the way that an S corporation is taxed for federal tax purposes. While a C corporation pays tax on its income at corporate tax rates, an S corporation does not. Rather, an S corporation files a return but pays no tax at the corporate level. The S corporation return is merely an informational return that details the corporation’s earnings and shows how the income was allocated among its shareholders. All of the S corporation’s income then flows through to its shareholders and is reported and taxed on the shareholders’ individual returns at each shareholder’s individual tax rate.

If an S corporation pays a writer-shareholder only a portion of the net earnings as salary, all of the S corporation income would be subject to income tax at the writer’s individual tax rates, but only the portion designated as salary would be subject to Social Security tax.

Let’s look at an example. Say Betty Bestseller has net earnings of $150,000 from her writing business in 2013. If she reports the entire amount of earnings on a Schedule C as a sole proprietor, she would owe a total of $18,448.80 in self-employment tax. This total includes taxes of 15.3% on the first $113,700 ($17,396.10) plus the 2.9% Medicare tax on the amount above $113,700 ($1,052.70). If she formed an S corporation and paid herself a salary of $75,000, the total Social Security taxes would be only $11,475 ($75,000 x .153). Thus, Betty would save $6,973.80 in taxes.

Sounds great, huh? But you know by now that nothing is that simple when it comes to taxes.

The problem is, Social Security taxes are not the only financial variable to take into consideration. When deciding whether it makes sense to form an S corporation, a writer must also consider the following:

1) The costs of forming and maintaining an S corporation can be significant.

In addition to the initial filing fees, legal and accounting services will likely be needed to ensure the writer is meeting its tax and other legal obligations. An S corporation return and payroll tax returns would have to be filed, resulting in additional fees to the writer.

2) The salary will be subject to federal and state unemployment taxes.

For 2013, the federal unemployment tax rate is 6% of the first $7,000 in wages or salary, for a total of $420. The federal tax can be offset by a credit of up to 5.4% for state unemployment taxes paid, thus potentially reducing your federal unemployment tax to .6%.

State unemployment tax rates vary. Check with your state labor board to determine your state’s rate.

Keep in mind, too, that because the writer owns the S corporation and thus controls whether he or she is “employed,” the writer is not likely to be entitled to any unemployment benefits should the writer en-   

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