S-Corp vs. Sole Proprietorship

For those who are considering entering private practice either as a full time, part time, or moonlighting basis, one often hears about the benefits of incorporating one’s business. But what exactly does that mean?

Obviously, incorporating one’s business affords an individual some form liability protection in the event of a litigation claim. However, what are the tax benefits associated with incorporating and should every CRNA who is interested in 1099 work incorporate his/her business? This article will explore that answer from a purely financial/tax perspective. At the end of the day, you have to think about what your priorities are and what your tolerance for risk is.

An S-Corp (short for a Subchapter S corporation) is treated like a partnership for tax purposes – all income and expenses pass through to the shareholders.  It offers limited liability in many cases, and there can be significant tax advantages if you put yourself on payroll. As a CRNA, your liability is likely to come from malpractice, in which case the charge goes against you personally through your license and the corp wouldn’t help.  It can protect your personal assets from recovery if you breach a contract signed with the corp. This is where malpractice coverage comes into play as it will help pay for the legals costs to defend a claim along with paying out the claim should a ruling favor the plaintiff.

The corporation will need to file its own tax return, an 1120S. The corporation will then issue you a K-1, which you will report on your own taxes on Schedule E.  S corporation tax treatment can provide a way to take some money out of your corporation without paying Social Security and Medicare taxes. This is because you do not have to pay this tax on distributions (dividends) from your S corporation—that is, on earnings and profits that pass through the corporation to you as a shareholder. The larger your distribution, the less Social Security and Medicare tax you’ll pay. The S corporation is the only business form that makes it possible for its owners to save on Social Security and Medicare taxes. This is the main reason S corporations have been, and remain, popular with small business owners.

However, not all the money you get from your S corporation can be in the form of a corporate distribution. An S corporation shareholder who performs more than minor services for the corporation will be its employee for tax purposes, as well as a shareholder. A shareholder-employee must be compensated for his or her services with a reasonable salary and any other employee compensation the corporation wants to provide. This salary will be subject to the same amount of Social Security and Medicare tax.

Self-employment taxes consist of a 12.4% Social Security tax on income up to an annual income ceiling, which is $128,400 for 2018 and a 2.9% Medicare tax not subject to any ceiling. Self-employment taxes are equivalent to the total Social Security and Medicare tax paid for an employee.

Example: Let’s say you start an S corporation in which you are the sole shareholder and employee. In one year the corporation has a profit of $70,000. You pay yourself a $35,000 salary as an employee and $35,000 as a corporate distribution. The salary is subject to Social Security and Medicare taxes, but the distribution is not. As a result, you end up paying $5,355 less than you would have had you been a sole proprietor as the entire $70,000 you made would have been subject to these taxes.

However, when you form an S corporation you will have some additional expenses that will eat into your tax savings. For example, most states require that each employee be provided with workers’ compensation and unemployment insurance coverage, which costs at least several hundred dollars per employee. Some states also require all corporations, including S corporations, to pay minimum annual state taxes, no matter how much money they earn. In California, for example, there is an $800 minimum annual tax. So, you’re looking at paying every year: the $800 minimum tax (or more, depending on how much you earn), tax prep for the corporate return, and probably a payroll company to pay out your salary. 

What About a Sole Proprietorship?

A sole proprietorship is not a separate corporate entity.  In fact, it is the most basic business structure available as all you would need to do is register for a trade name (a DBA – ‘doing business as’) and use that to set up a business bank account. Additionally, you would only need to file your taxes on Schedule C of your normal tax return.  You don’t get limited liability (nothing changes with malpractice though), and you can still deduct 100% of your business expenses.  Once you set up the DBA, it only needs to be renewed once every 5 years.  You can do that online for a $26 fee. 

When you’re a sole proprietor, you are not an employee of your business entity. Instead, you are a business owner—also called self-employed. Your business doesn’t have to pay payroll taxes on your income or withhold income tax from your pay. It need not file employment tax returns or pay state or federal unemployment taxes. You need not be covered by workers’ compensation insurance. All this can save hundreds of dollars per year. However, the biggest difference between an S Corp and sole proprietorship is the lack of liability protection, meaning your personal assets are exposed with your business assets in the event of a litigation claim and you’re a sole proprietor. However, you do have to pay self-employment taxes—that is Social Security and Medicare taxes—on your business income, even as a sole proprietor.

Conclusion

It comes down to whether you will save enough in payroll taxes to justify the $800 minimum tax, extra tax returns, and so on.  To that end, whether you should form an S-Corp depends on how much you are going to bring in every year and your attitude towards the exposure of your assets. However, irrespective of whether you’re an S-Corp or sole proprietor, just know that you can deduct 100% of your business expenses and that you will be subject to paying self-employment taxes for both business structures.

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