1120S vs Schedule C for low income TPs

I've seen several posts saying that S corporations are not a good idea for many low income businesses. I find that hard to understand. The reduction in employment taxes is significant and it seems to me that shifting info from a Schedule C to an 1120S should not be an expensive process. What am I missing? Is it merely that clients are not capable of managing the process in an efficient fashion in order to reap the benefits?

We keep wondering why you beat this drum.....

Low income: Let's say they earn 30k profit. Are you going to argue that they should have a reasonable salary that's less than THAT? No way. But let's suppose you're super aggressive and decide salary should be 20k. So they have 10k less taxed for SS, saving 1500, which just covers the cost of running payroll, 1120S, somebody keeping better books, state annual fee and unemployment. And that's IF you can justify a low salary. And I left out legal fees annually.

Just doesn't work for me until profits hit 50-60k for most folks when you look at comparable salary sites.

And not to mention that getting OUT of the corp costs if the plane don't fly. Many sole props never get beyond small or just move onto something else. Now you have to kill it. More legal fees, more accounting fees....

I've helped kill 4 S-Corps over the past 5 years...here are their common profiles:
Revenue less than $40K
No reasonable comp, no W-2
Net income less than $25K

Now tell me why they should be S-Corps.

I agree with all above...
On top of that, you're introducing a meaningfully sophisticated structure to a meaningfully unsophisticated individual and/or arrangement.
We haven't mentioned exit strategy yet either. There is a cost to exiting an s-corp. There's no value in creating a structure with this inherent known cost if there isn't enough benefit along the way AND you don't have a meaningful enough activity to warrant such.
At best, advising an s-election for a low income business is ignoring the entire context of what the election means.
At worst, this is a way for professionals to pad fees with no meaningful benefit to the client.

I start thinking S Corp when a client will consistently have net income of a $100k plus per year


If you factor in $2,500 of S Corp Tax prep fees, $1,000 for payroll service , $500 state fees each year you better be saving the client at least that to justify it.

So how do you save $4,000? If You have a $100k net income on Sch C and that goes to $75k W-2 and $25k net income as an S Corp it comes close

Someone making $30k needs all of that to be getting recorded as SS wages unless this is some type of side gig. But you said low income folk so that is not the case

And it should be noted that if it IS a side gig, S corp is terrible since there's no way to avoid the corp side of SS tax if they're over the ceiling. So Sch. C is better since it won't be subject other than for Medicare tax assuming they're over ceiling.

You guys must be in big firms. $2500 more for an S than a Schedule C for a guy making $30k? Really? Is the payroll service fee higher for an S than a sole pro?

We're talking about low revenue, low assets and few, if any, employees. At $30k/yr I suggest a salary of $10k or less, saving about $3k in employment taxes. And while we can speculate about a reasonable comp issue, tell me what you think the odds are that this would arise in the real world. And don't forget the S corporation can walk from IRS penalties.

The idea that a small company with minimal assets has some sort of problem with an exit strategy is not something that strikes me as significant in the real world. The question here is what's in the client's best interests. A $100k rule of thumb is ludicrous.

While I agree that $30k presents a marginal case and that some clients can't handle the paperwork, if you really want to see how to save taxes for a guy making, say, $50k/yr, check out my post re LBO's with controlled buyers. Seems too sophisticated for such a small deal, but boy can you make a difference in someone's life...

S Corps need corporate books - i.e a trial balance. These small businesses don't have the knowledge to do this. Or can't afford a good bookkeeper even if they could find one. They frequently mix business and personal accounts, expenses, etc. In other words they are a mess. We have to charge to clean it up. $2,500 is about our minimum for these typical messes.
I won't recommend S Corp unless the net is $100K or more and client will commit to payroll and accounting.

10k reasonable? Steve. Seriously, you just shot whatever creds you had to hell. It doesn't matter that it likely won't be caught, but you're being a hog and allowing your clients to be hogs. Sorry, I'm saying it's unprofessional....could even be considered aiding and abetting what is obviously wrong. There's that 5k penalty still in place lobbed against tax pros who play too fast and loose. You making that much from that client to risk that?

Sorry that's all quite harsh....but I've been at this awhile and have always been aggressive where I can. But just because there's little to no audit risk does NOT allow us to fly crazy. They won't audit advertising expense, either, why not just book some of that for putting a decal on the car?

If you have a sole owner, no employees, I struggle to comprehend that there are too many businesses that could justify a salary as low as $10,000 on $30,000 profit.

My payroll fees are less than $1,000pa but not by that much. Even a $500 fee for an S corp return (I inherited clients with low fees) eats into the social security advantage. What about tracking basis on the S Corp return. It seems to me double-entry bookkeeping is the cheapest way of doing that. Another cost. So the savings are not so great in the end. Instead of tinkering at the margins, one might also argue that spending professional time on added-value services helps the adviser and the client.

The idea that a small company with minimal assets has some sort of problem with an exit strategy is not something that strikes me as significant in the real world. The question here is what's in the client's best interests. A $100k rule of thumb is ludicrous.

I think we've established your opinion is different than most of the rest of us on this dynamic. My experience in the "real world" is exactly what has informed my opinion on the matter. As a younger, newer practitioner, I would have been more likely to agree with you in part. That's not a dig at your experience or expertise, just me sharing how I came to form my opinion. Conceptually, what you describe works. In practice, I haven't experienced it.
What I don't see is many other folks jumping in and saying they align with your approach. Not saying there aren't any, but they haven't chosen to chime in.
I'm pretty much perfectly aligned with SJR's comments above.

Plus, that guy taking $10K instead of $30K is reducing his future SS benefits that he will likely need more than most. You know the FICA savings aren’t getting invested.

Gator, your tax savings analysis omits the effect of unemployment taxes, the higher income taxes paid (lower deduction for employer-side FICA than SECA and lower QBID), state entity fees that might not be necessary for just a Schedule C filer, etc. So when you add that to the fees to do yearly payroll and 1120S, it begs the question about how much benefit is the client actually keeping?

Truthfully, if a client is operating a business that nets $30k, the last thing we should be worrying about is an ultimately minor amount of money through a strategy that is too aggressive for JR1! For a client in that situation, we should be spending our time working with them to grow their business so that they make $40k, $50k, or more a year, which has a much larger return for the client than just S corping it. And if the client grows the business, then we can talk about the S corp if it's appropriate.

Or we need to have the hard conversation with our client on if it would ultimately be best that they get a job working for someone else.

LOL. What are you saying, Missing? lol

I'm in agreement with the majority here. First, you have to pay someone to form the corporation and elect S status, as most cannot do this themselves. Once an S Corp, you need to keep good books and records (ie double entry accounting) or hire an accountant to clean things up. You need to have corporate minutes. You have to run payroll and file payroll tax reports. W-2's have to be issued at year-end. Corporate tax returns have to be prepared. All of those things add up to quite a bit of costs.

I will usually begin suggesting forming a corporation once the profits are around $60,000-$75,000, depending on the client and the growth of the business.

LOL. What are you saying, Missing? lol

Actually, it's a compliment. I've been reading you and others here here since it was the old TaxAlmanac board, and you're aggressive when it's possible but you tend to have some pretty no-nonsense limits on it. If I'm reading a post and find that you wouldn't take as aggressive of a position as I would, it makes me think twice.

LOL. What are you saying, Missing? lol

Actually, it's a compliment. I've been reading you and others here here since it was the old TaxAlmanac board, and you're aggressive when it's possible but you tend to have some pretty no-nonsense limits on it. If I'm reading a post and find that you wouldn't take as aggressive of a position as I would, it makes me think twice.

I'm frustrated. My post is not showing up.

To make a long story short, I appreciate your comments. We all draw our lines in different places. At least I know there is nothing significant I am not considering.

BTW, the guy making $100k can save about $8k using the LBO technique. That's about a month a year of not working for the IRS.

At the risk of beating a dead horse; first off a 10,000 salary is less that $5 and hour and nobody in their right mind could pretend that was reasonable compensation and secondly income from an S corp K-1 is not earned income so you would be locking the taxpayer out of Earned Income Credit, Dependent Care Credit and assorted other goodies like being able to contribute to an IRA.

An S corp for somebody netting 30,000 is just a completely bad idea.

I am aware of those things. We disagree as to whether an S for low income TPs is worthy of consideration. So be it.

BTW, I don't have any low income clients, other than an occasional collections matter. So it's fair to say I'm bloviating...

But as a matter of theory, what's the realistic downside of taking a salary of one-third of S pre-salary income?