You’re around the table at dinner sharing a drink with your friends (beer, wine, non-alcoholic — we don’t judge). Your friend says, “You know, ever since I elected my PLLC to be treated as an S Corporation, I’ve just been flabbergasted at the tax savings. Sure, there’s some added complexity and I have to shell out payroll taxes now, but it’s worth it. Trust me!”
Your other friend chimes in, “Yes, but first you have to make sure that it’s worth your while. At lower amounts of gross income, the tax benefits just don’t pan out and you end up with added legal complexity and nothing to show for it.”
We’ve all been there, right? Well, probably not. Instead maybe you have seen Therapists post on social media talking about becoming an S Corporation to save tons of money.
Maybe you feel like you don’t know that much about S Corporations, and that’s okay. We’re here to help! By the end of this article, you will hopefully have a better idea of how close your company is to the point where it’s “worth it” to make the S Corporation election. Remember that this is different for every practice.
Become a PLLC or LLC First (If You Aren’t One Already)
Is your business a PLLC or LLC (what’s the difference?), or another type of corporation? In Washington State a Therapy Practice should be a PLLC, though other states may have different requirements or recommendations.
If you are none of the above, then you’re not ready for the S Corporation election for a very important reason: you’re not a corporation yet. Every business has to become a corporation of some kind first before making the S election. (You can directly become an S Corporation but we don’t recommend this since it’s most likely not worth it if you’re just starting your practice.)
If you are currently providing therapy services to clients but you’re not a corporation, then it is important to know that you do not have limited liability protection. Limited liability protection means that if your business is sued for all it is worth and then some, there is a barrier keeping the courts from reaching into your personal savings and checking for damages. This is important.
In short, if you don’t have limited liability protection and you are doing business now, check out our guide on how to become a PLLC. Or just give us a call!
If you really don’t want to incorporate, then at least sign up for malpractice insurance to protect yourself.
Let’s Talk Numbers
We’re no strangers to frank discussions about the numbers: income, salary, bank balances, and taxes. What was your gross income over the past year? If your gross income was $85,000 or more, then it’s likely time to consider taking that S election.
Gross income is not the only numerical consideration here. When you look at the numbers over the past year (or at least the past few months), has your cash flow been steady enough to support a salary for you? The benefits of having an S Corporation fade away when you are unable to pay yourself a salary. This is not the end of the world, but there are upfront costs involved in making the S election that ideally should at least pay for themselves.
If you haven’t heard the phrase “reasonable salary” before, you’re going to hear it a lot when you talk about setting up an S Corporation. Specifically, you will be expected to pay yourself a reasonable salary. The basics behind the concept of a reasonable salary include:
- Figuring out how much time you spend on different activities. Let’s say you spend your time like this in a 40-hour week:
- 8 hours a week doing administrative stuff like answering phone calls and emails,
- 4 hours a week doing sales-type activities, putting the word out about how awesome you are,.
- 2 hours a week keeping your books, and
- 26 hours a week doing actual therapy.
- Determining what kind of salary a person doing each activity would earn if you were to hire an employee to do it for you. Let’s say for example:
- Admin support would earn $15 per hour
- Sales would earn $30 per hour
- A bookkeeper would earn $20 per hour
- A therapist would earn $35 per hour
- Taking a weighted average of these different tasks that you do. Thankfully this boils all the numbers down into one number. In our example, this number is $29.75. So, as a Wearer of Many Hats (or, a Voltron employee) your annual salary would be $29.75 * 2080 = $61,880.
If this all sounds a bit complex, rest assured that all you need to do is tally the hours per week you do different tasks, and we can take care of the rest with a salary survey. Just schedule an appointment.
If you’re wondering why you can’t just name a salary, it’s because the IRS wants to make sure you’re not trying to cheat them out of payroll taxes. It’s true that you can pay an employee pretty much any amount you want (as long as it’s at least minimum wage), but reasonable salary is a circumstance where more government regulation steps in.
Now, ideally you will be able to pay yourself distributions in addition to your salary, because this is the situation where you’ll see the most tax benefits of running an S Corporation. So if your cash flow is struggling, especially during COVID, it might be worth waiting to upgrade until you have a firmer financial foundation.
How Are the Books?
Does going to see your accountant feel like going to the dentist? Does the question “When’s the last time you reconciled?” feel eerily similar to the question “When’s the last time you flossed?” If this is the case then it’s probably not time to make a major change to your financials such as the S Corporation election.
Look, we’re not in the business of guilting people for going a bit lax on their bookkeeping hygiene. On the contrary, it actually feels really good to finish a full bookkeeping clean-up on a client who really needed it. If your books are in dire need of attention, give us a call and we can sort things out for you — then we can start talking about upgrading to an S Corporation if you desire.
How Do You Feel About Added Complexity?
We’ll tell it to you straight: Your life will be more complex after you upgrade to an S Corporation. Sure, there’s the upfront cash outlay to do all the legal work as well as the continuing cost of payroll software. But beyond all of these considerations, it’s important that you know that if legal complexity is a pain for you, it’s going to be more of a pain after making this upgrade.
But that’s what it’s all about: The added legal pain should be more than made up for in tax savings!
TL;DR: Is it time for your business to make the S Corporation election? Well, I’m afraid we’ll have to answer the question with a question… or more like 3 questions. Are you a PLLC already? Is your financial situation healthy? Have you been sufficiently f̶l̶o̶s̶s̶i̶n̶g̶ maintaining your books? If the answer to all three questions is Yes, then maybe you’re ready. Call us and find out for sure!