If you own a small business in Wisconsin, you’ve probably heard some version of this advice:

“You should become an S Corp. It’ll save you money on taxes.”

Sometimes that’s true.

Sometimes an S corporation election adds payroll, tax filings, accounting costs, and administrative work without producing enough tax savings to justify it.

The important question isn’t simply whether an S Corp can save taxes. It’s:

At what point does an S Corp make sense for your business?

Here’s what Wisconsin business owners should understand before making the change.

First: LLC and S Corp Don’t Mean the Same Thing

One of the most common sources of confusion is treating an LLC and an S Corp as two competing types of businesses.

They’re not exactly the same thing.

An LLC, or limited liability company, is a legal business structure.

An S corporation is a federal tax classification.

That means a business can actually be both an LLC and taxed as an S corporation.

For example, you might establish an LLC with the State of Wisconsin and initially have the business taxed as a sole proprietorship. Later, you could elect for that same LLC to be taxed as an S corporation.

You don’t necessarily need to create an entirely different business.

How Is a Single-Member LLC Normally Taxed?

By default, a single-member LLC is generally treated as a disregarded entity for federal income-tax purposes.

For many business owners, that means reporting business income and expenses on Schedule C of their individual tax return.

Suppose your business has:

$150,000 of revenue

minus

$50,000 of business expenses

leaving:

$100,000 of net business profit.

That $100,000 generally flows through to your personal tax return.

In addition to federal and Wisconsin income taxes, a self-employed business owner may also owe self-employment tax on applicable earnings.

And that’s where the S Corp conversation usually begins.

How Does an S Corp Work Differently?

An S corporation is also generally a pass-through entity, meaning the business itself typically doesn’t pay federal income tax on its profits in the same way a C corporation does.

Instead, income generally passes through to the owners.

However, there’s an important distinction.

If you work for your S corporation, you generally need to pay yourself reasonable compensation as an employee.

That salary is subject to payroll taxes.

Additional business profit distributed to you as an owner generally isn’t subject to self-employment tax in the same manner.

That difference can potentially create tax savings.

An Example of How an S Corp Could Save Taxes

Let’s use a simplified example.

Suppose your business generates $100,000 of profit before paying you compensation.

As a sole proprietor, most or all of the applicable net earnings may be subject to self-employment tax.

Now suppose the business elects S corporation taxation.

After considering your responsibilities, industry, experience, hours worked, and other relevant factors, let’s assume $65,000 represents reasonable compensation for illustration purposes.

You might have:

Salary: $65,000
Remaining S Corp profit: $35,000

The $65,000 salary is subject to applicable payroll taxes.

The remaining $35,000 of S corporation profit generally isn’t subject to Social Security and Medicare payroll taxes in the same way wages are.

That’s the basic source of the potential S Corp tax advantage.

But there’s an important catch.

You Can’t Just Pay Yourself a Tiny Salary

If you’re thinking:

“Why not pay myself $10,000 and take everything else as a distribution?”

That’s exactly the type of strategy that can create problems.

The IRS requires shareholder-employees to receive reasonable compensation for the services they provide before taking non-wage distributions.

There isn’t one universal reasonable-salary number.

Factors can include:

• Your training and experience
• Your responsibilities
• The amount of time you spend working
• What similar businesses pay for comparable work
• The size and complexity of your business
• Compensation paid to other employees
• Your industry
• The services you personally perform

The appropriate amount depends on the circumstances.

An S Corp shouldn’t be viewed as a loophole for avoiding payroll taxes on compensation that should reasonably be treated as wages.

So When Does an S Corp Actually Make Sense?

There’s no single profit number at which every Wisconsin business owner should make an S election.

That’s because you need to compare the potential tax savings against the additional costs and complexity.

At very low profit levels, an S Corp may provide little or no meaningful benefit.

As profits increase beyond what would represent reasonable compensation for the owner’s work, the potential benefit can become more significant.

For example, imagine two businesses.

Business A

Annual profit: $45,000

If reasonable compensation for the owner’s work would already consume most of that profit, there may not be much income left to receive the potential payroll-tax advantage.

The additional administrative costs could outweigh the savings.

Business B

Annual profit: $175,000

Suppose reasonable compensation is substantially below the total business profit.

There could be significantly more income remaining after reasonable compensation, potentially making an S Corp election more attractive.

These numbers are only illustrations. The appropriate decision requires looking at the specific business and owner.

Don’t Forget the Additional Costs of an S Corp

Tax savings shouldn’t be evaluated in isolation.

An S corporation generally creates additional responsibilities.

You may need:

• Payroll processing
• Regular payroll-tax deposits
• Quarterly payroll-tax filings
• W-2 preparation
• A separate S corporation tax return
• Additional bookkeeping
• Wisconsin business filings
• More involvement from your accountant or tax professional

Those things cost money.

Suppose an S Corp strategy saves you $3,000 in taxes but creates $2,500 of additional annual accounting, payroll, and administrative costs.

Your actual benefit is much smaller than the headline tax savings suggest.

That’s why we prefer looking at the net benefit, not simply saying, “S Corps save taxes.”

There Are Other Tax Considerations Too

Payroll taxes aren’t the only factor.

An S corporation election can affect other areas of your tax situation, including:

• Retirement-plan contributions
• Health-insurance deductions
• Qualified Business Income deduction considerations
• Estimated taxes
• State taxes
• Business losses
• Fringe benefits
• How you take money out of the business

That’s another reason an S Corp decision shouldn’t be based solely on a rule of thumb you saw online.

What About Wisconsin Taxes?

Wisconsin generally recognizes the federal S corporation election, but operating an S corporation in Wisconsin can create additional state filing and compliance responsibilities.

Your overall decision should therefore consider both federal and Wisconsin tax consequences, along with administrative requirements.

If you’re a Wisconsin business owner, it’s worth reviewing the complete picture before changing how your business is taxed.

When Should You Consider an S Corp?

An S corporation conversation may be worthwhile if:

• Your business is consistently profitable
• Your profit has increased substantially
• Your business earns considerably more than a reasonable salary for the work you perform
• You’re currently reporting substantial self-employment income
• You expect your business to continue growing
• You’re willing to run payroll and maintain additional records
• The potential tax savings meaningfully exceed the added costs

On the other hand, an S Corp may be less compelling if your business is new, has inconsistent profits, or produces only enough income to reasonably compensate you for your work.

Don’t Make the Decision Based on Revenue Alone

This distinction is important.

A business with $300,000 of revenue isn’t necessarily a better S Corp candidate than one with $150,000 of revenue.

What matters much more is profit.

Consider:

Business #1:
$300,000 revenue
$250,000 expenses
$50,000 profit

versus:

Business #2:
$150,000 revenue
$30,000 expenses
$120,000 profit

Business #2 could potentially have a much stronger case for considering an S Corp even though its revenue is half as large.

When evaluating an S election, focus on what’s left after legitimate business expenses—not just the amount coming through the door.

Don’t Wait Until Tax Season to Ask

Entity selection is a perfect example of the difference between tax preparation and tax planning.

When we’re preparing your return, we’re largely reporting decisions that have already been made.

Tax planning gives us an opportunity to look forward.

If your business is growing, don’t wait until you’re handing your documents to your tax preparer to ask whether your current structure still makes sense.

Reviewing it proactively gives you more time to evaluate:

• Your current profit
• Expected future profit
• Reasonable compensation
• Potential payroll-tax savings
• Payroll costs
• Accounting costs
• Retirement planning
• Other tax consequences

The goal isn’t to create the most complicated tax structure possible.

It’s to determine whether a different structure produces a meaningful benefit for your particular business.

Should Your Wisconsin LLC Be Taxed as an S Corp?

There isn’t a universal answer.

For some Wisconsin business owners, an S corporation election can create meaningful tax savings.

For others, it simply creates additional paperwork and expense.

At La Crosse Tax, we can help business owners look at the numbers and determine whether an S corporation election is worth considering based on their actual situation.

Rather than relying on a generic income threshold, we can compare the potential savings with reasonable compensation, payroll costs, tax-preparation costs, and other consequences.

Wondering whether an S Corp makes sense for your business?