Explanation

An important issue to consider when deciding the structure of your business is self-employment tax. Self-employment (SE) tax is a 15.3% tax on income.

This rate, 15.3%, is a total of 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

The SE tax rate for business owners is 15.3% tax of the first $160,200 of income and 2.9% of everything over $160,200.

SELF EMPLOYMENT TAX
Type of Tax	Tax Base	Rate	Maximum Tax
Social Security	$160,200	12.4%	$11,680.80
Medicare	no limit	2.9%	no limit

Normally these taxes are withheld by your employer. However, if you are self employed, it is your responsibility to pay them yourself.

S corporations have a significant advantage when it comes to the payment of SE taxes. In an S corporation, only the salary actually paid out an owner/employee as compensation for services is subject to SE tax. Any money left in the business for reinvestment or distributed to the shareholder as a dividend is not subject to payroll taxes...and not subject to self-employment tax.

Owners of sole proprietorships, partnerships and LLCs however, pay SE tax on their respective share of profits rather than salary. (Certain types of LLC income, however, are not subject to self-employment tax. For example, rentals from real estate and capital gains are not considered to be self-employment income, so real estate LLCs often need not be concerned with self-employment tax.)

Here's an example: Say you have net income of $90,000 and pay yourself $60,000 in salary, leaving $30,000 in the business to pay for equipment. As a sole proprietor, you would pay self-employment tax on the full $90,000 ($90,000 x 15.3% = $13,770). But as an S corporation, you would only owe self-employment tax on the $60,000 in salary ($60,000 x 15.3% = $9,180), resulting in a savings of $4,590.