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Hit 7 figures but losing 5 figures to taxes? Earn a 6-figure income but feel financial chaos? Welcome to the show helping you Simplify Your Numbers.
Most business owners in the $1M–$10M range feel like "passive payers"—surprised by a massive bill every April and wondering why their hard work isn't reflected in their bank account. Host Fabrice Metan, a veteran CFO and tax strategist, cuts through the noise of complex financial data to provide straightforward, actionable insights for the "7-6-5" entrepreneur.
This podcast is the bridge between traditional bookkeeping and high-level advisory. We move you away from a reactive "compliance mindset" and into a proactive strategy where your business becomes your greatest wealth-building tool.
Stop being a passenger in your own financials. It’s time to simplify your numbers, maximize your profit, and hold onto more of what you earn.
Subscribe to join the 7-6-5 community and start your transformation today.
Ep02
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S Corp Tax Trap
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Fabrice Metan: [00:00:00] This real estate investor put his long-term rental properties under an S corp and paid $30,000 in self-employment taxes he should have never owed. Is your S corp at risk of costing you more than it's helping you? Find out now.
Fabrice Metan: [00:01:00] All right. And so in this episode, what I'd like to talk about is everything you need to know about the S-corp. You know, you hear online TikTok reels, everyone wants to be an S-corp, and they don't quite understand the good, the bad, the ugly. And so let's break that down for a little bit.
What Is an S Corp
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Fabrice Metan: What exactly is an S-Corp.
First of all, it is a tax election and not an entity. The reason why I say that is you have to be an LLC to then convert into an S Corp or a C Corp that eventually converts to an S Corp. You are already an entity and then file for a tax designation or a tax structure or how you would like the IRS to tax you.
That is the S Corp.
Now [00:02:00] in contrast, you have your single member, LLC, or multi-member LLC. The multi-member LLC is typically taxed as a partnership by default. Single member LLC is taxed as a sole proprietorship or a disregarded entity. In other words, your personal tax return would include a Schedule C with the information of your single member, LLC.
And when you a partnership or a multi-member LLC, you essentially file a partnership tax return for you and your partners. Now, when you convert to an S corporation, you actually have a separate tax return called an 1120 S form. That you file for that S Corp. Similar to a partnership, you're going to receive a K one from your S Corp, even if we're dealing with a single member LLC, right?
Self Employment Tax Basics
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Fabrice Metan: The biggest difference here is that under the single member LLC, all of your income is subject to [00:03:00] self-employment taxes, which is essentially what we call the F word, fica, Medicare, social security, taxes, all of that. When you are an employee, a W2 employee, you pay seven point 65% in FICA taxes, and your employer is expected to match that number and pay another 7.65%.
Well, guess what? When you're self-employed, you are both the employee and the employer, so you're paying both sides. That becomes 15.3%. Now as a single member, LLC, what happens is all of your earnings, all of your net profit in the business, meaning income minus all of your expenses, that bottom line number a hundred percent of that number gets subject to self-employment taxes.
So in your tax return, you would pay 15.3% of that total.
Salary vs Distributions
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Fabrice Metan: When you convert to an S corporation, you now have the opportunity to actually pay yourself a reasonable salary. [00:04:00] And Then separate the rest of your earnings and take those earnings as distributions from your S corp. What happens there is that only the salary will now be subject to the self-employment tax, so you only pay that 15.3% on your salary, but not on the rest of your net profit.
That is the powerful side of the S corporation. It doesn't necessarily magically eliminate your taxes, but your taxes get reduced simply because of the tax structure and how your income gets divided. As an S Corp owner, you're considered an officer, someone who actually works for the business and is supposed to receive a reasonable salary from that business.
But you are also on the other side, an owner of the company who's receive, supposed to receive. some payments for their investment in the business, almost like you're getting rewarded for being the owner of the company. So that [00:05:00] portion is almost considered passive to a certain extent.
It's not considered self-employment, it's not considered additional money that you received because of the work that you did in a business that is in your salary. Does that make sense? So you have an opportunity to now separate your earnings into two separate buckets that are taxed very differently.
And so why is the S corp considered a tax holy grail for multiple reasons. First of all, reducing your self-employment taxes, just as I mentioned, right? So a good chunk of your earnings of your net profit can now be in this bucket that is sheltered from the 15.3% tax,
Reasonable Compensation Rules
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Fabrice Metan: but it's very important to understand the reasonable compensation. And the reason why I say it's very important to understand it is because the iris makes it very blurry and very gray and very confusing, right? The average business owner cannot figure out what his reasonable compensation should be, but I can give you three steps as [00:06:00] a guideline to determine that Number number one, you wanna make sure that you look at what someone like yourself in the business that you run would typically make in the market.
So let's say that you run a production company, right, and you're the owner or you're the president of that production company. What would someone like yourself actually earn in the market for a similar job? The second thing to look at is, well, it's one thing to find out that someone like myself earns $150,000 a year in my market, but what if my business doesn't actually have that kind of money to pay me at that very moment?
Now we have to look at the net profit of the business to adjust between a certain line. That is, how do we remain profitable in our business and reinvest enough money compared to how much can I take to pay myself in this business? And the last thing that I like to look at is the [00:07:00] amount of distributions that you actually plan to take that year.
Right? And so what you can do is. Take a $10,000 W2 income and then take $200,000 in distributions. That's too easy, right? The IRAs understand that you converted to an S corporation because you want to minimize the amount of self-employment taxes that you pay. So that is the reason why they talk about the reasonable.
Compensation because it still has to be reasonable. You cannot have enough cash flow to take $200,000 in distributions and then only give yourself $10,000 in W2 wages because you know that your self-employment taxes would only apply to the 10,000, right? So the IRS wants you to be in that middle, and how do you find that out?
We want to be able to take all three of those factors and determine what your reasonable compensation. Amount should be. That's why anytime we convert a client to an S corporation, we make sure to do a reasonable compensation study to [00:08:00] determine what that number should be before filing any of their returns, their payroll, determining how much they need to pay themselves, et cetera, et cetera, et cetera.
And I can give you, you know, in terms of numbers, right? A lot of people would say, well, what does that really look like for me? Right?
Real Client Savings Examples
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Fabrice Metan: So I'll give you a couple of of examples for real, real clients in real situations that we've dealt with. End of the year, we have a client who is in the granite business.
I, if I remember off the top of my head, the company was generated 2.1 million in gross revenue, right? So seven figures again. The partners is, it was actually a partnership. Two. Two partners. The business Nets $335,000 for the entire tax year, six figures, and the owners were already taking about $115,000 in distributions for each of them.
Throughout the year, but at that time, they were still being taxed as a partnership [00:09:00] from being a multi-member LLC and so in this situation, we converted them as an S Corp before the deadline after our reasonable compensation study, we determined that each of those officers, right, the owners are now converted into officers, should have paid themselves a reasonable salary of $60,000 in W2 wages for each of them, right?
So $60,000 of the $115,000 distributions that they've taken will now be converted from distributions to W2 income. And I'm pulling out my calculator to give you some numbers, right? So $60,000, the self-employment tax on that would be 9,180 for each of them. So in total, that is $18,360 in contracts.
Without being an S Corporation, they would've had $51,255 in self-employment taxes to pay. [00:10:00] Compared to about $18,000, that's a $33,000 tax savings. That's the type of stuff that the S Corp can do for you. Another client of ours was an engineering consultant, used to get a 1099 income for about $225,000.
So every year receives a 1099 for $225,000. And of course, because it's a 1099 we get to report it on the Schedule C. So inside is personal tax return. Take out all of the business expenses he might have because he's more in the service, kind of a service provider, not a lot of write-offs, right?
To claim against that income. So probably had about $50,000 in write-offs that put him at about $175,000 of income. That he was paying comfortably $27,000 in self-employment taxes on. And keep in mind when we talk about self-employment taxes, that doesn't take away from the federal and state withholding taxes that you already pay, right?
That is in [00:11:00] addition, right? Your federal and state income taxes are generally dependent on your tax bracket, depending on where your taxable income falls. We would determine how much in taxes you would actually pay your withholding taxes, but that is federal and state. That has nothing to do with a self-employment tax that applies to your business income.
Very important. Right? And so for that owner, essentially when he came to our office, we were able to determine what the reasonable compensation should have been and limited his W2 earnings at a hundred thousand dollars. The self-employment tax on that amount would now be 15,300. As opposed to the $26,000 that they would've already paid on their earnings.
And so now you have about $11,000 in tax savings just by converting that single member LLC or that 10 99 income into an S corporation.
When S Corp Is Bad
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Fabrice Metan: Now, , When is your S-corp a bad idea? Because here's the thing, right? We are [00:12:00] in an era where we're all on social media. We're all hearing so-called experts sharing information and telling you that this is how you should be structured. I get about 10 to 12 videos. Sent to me by clients trying to find ways to limit their taxes and always trying to see, Hey, Fabrice, can we do this?
Hey, what about this? And it might not even apply to their situation, but hey, they just saw it on social media and wanted to know, right? And so I'm happy to take all of that, all of those messages and and to try to help them as much as possible. But let me break down when your S Corp might be a bad idea.
Number one, when you have inconsistent income. When you're not exactly sure if you'll be able to have a certain amount of profit every year to justify a salary for yourself, right? So you have a lot of businesses that are either seasonal or very dependent on the economy or different factors that essentially will not [00:13:00] guarantee that you can make X amount of dollars.
So until you get some consistency, it's probably not the right time. When you have low profit margins, right. Generally, I would say that unless your business can consistently pay you at least $50,000 in profit every year, there's no point in becoming an S Corp And the reason why is because the S Corp comes with its own complexity, right?
A lot of complications, especially when it comes to payroll. If you're an S corp, you now have to pay yourself a reasonable salary on a consistent basis, right? That could be weekly, biweekly, monthly, quarterly. I would recommend at least quarterly, right? But essentially pay yourself a W2 income throughout the year.
And when you receive a W2 income, you also have to remit. Payroll taxes, federal and state, depending on where you live. And so if you have all of that, there's a lot of payroll tax forms that have to be filed on a quarterly basis to reconcile all of the payroll taxes that you should have [00:14:00] paid throughout the year.
So it brings a certain level of complication or complexity that honestly, unless you're able to have a professional help you through that process. Probably not worth it. So you always have to measure the benefit with the administrative, the administrative cost, right? Because there will be some administrative cost to run it, but a lot of the times, you know, we're looking at clients that are able to save 20, 30, $40,000 in taxes.
So to them paying eight to $10,000 in administrative cost, far outweigh. You know what I mean? The potential risk, right? So they just pay that and save another 20, 30, $40,000. It's also not a good idea for early stage business. I wouldn't recommend that you start your company and automatically convert to an S corporation.
I would rather you start as an LLC or sole proprietorship and see how well your business grows before you decide to convert another.
Passive Rentals Warning
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Fabrice Metan: Situation in which I would [00:15:00] not recommend is when you have passive income businesses like owning long-term rental properties, which is where we go back to the story that I mentioned at the start of the episode.
When you have rental properties, those properties are considered passive income. In other words, on the income that you make from your rentals, you technically aren't supposed to pay self-employment taxes of 15.3%. That income is sheltered from that. At the same time, if you have passive losses, on the flip side, your ability to deduct your losses against ordinary income would be subject to passive loss limitations.
This particular client that I'm referring to came to us with somewhere around 40 rental properties that were all very profitable because some of them were owned outright. By that time, there wasn't really a lot of mortgage interest paid on it. Some of them were in locations where the property taxes were really [00:16:00] low.
Some of them were maintained so well over the years that them. Cost of maintenance and repairs was extremely low. So all of his properties were very profitable, but they were owned under an S corporation. And so you look back at the previous tax return and it looks like they made a lot of profitable, right?
A lot of profits under their entity and ended up paying that self-employment tax on all of those properties. So when I found out that these were all passive rentals. It made absolutely no sense to me that they were withheld under an S corporation. I would typically, for a real estate investor, I would typically recommend the scorp if you are in the fix or flip business, because then you're generating a lot of profits throughout the year.
And you need to limit the amount of self-employment tax that you pay on that profit. Very different from a passive income entity where, you know, a lot of the times you have losses on paper, even though you could be cashflow positive and still have losses. Right? So those are the things that we have to think about.
And [00:17:00] so the la, last but not least, you have to think about situations where the compliance costs far outweigh your tax savings. So the Scorp is not for everybody, and I don't want it to be a tax trap for you.
Deadlines and Late Election
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Fabrice Metan: Now, one of the last things I wanna mention about the Scorp is also the deadline. Right every year for you to qualify as an S Corp for that particular tax year, you're supposed to file the S Corp election form before March 15th of that year. Now, the IRA still allows you to file a late filing election with proper explanation.
So if you have a professional that can determine why you were not able to file before March 15th, and that you want to catch up towards the end of the year, we do that a lot. We can write a late filing election clause to include on that form to explain to the IRS why you should still be approved as an S corp for that particular tax year.
Now, [00:18:00] one of the, the main things that also you could essentially qualify for is that you always gotta remember. Generally you can qualify within, I believe, three years and 75 days of the actual deadline, right? Of your S corporation. And so from the time that you created your entity, you have all of this time to still qualify for late filing election if you can prove that you behaved as an S corp and that was your intention all along, right?
And so you have to be very intentional about the deadline situation. That reminds me of a story, a client that came to us at the beginning of this year, so in January, right, and said, Hey remember last year I received 10 99 income from the entity that I've been helping essentially as a contracted executive director.
And this year it so happened that they're going to pay me three times as much as they did. In the previous year. And so I'm [00:19:00] expecting that my 10 99 would be for about $150,000. And he tells me, well, is it still a good time for me to create an LLC and convert to an S corporation for the previous year? Unfortunately, no, you can't really do that.
Why? Because you are about to receive your 10 99 income as you the individual. So if you were to create an LLC today and convert that LLC into an ES corporation. Technically that LLC did not receive that income, that LLC was only created as of this day. You received that income all of last year, and so now you don't really have an entity under which we could have transferred the money as an S S Corp.
Now, on the flip side, imagine that the client called me in the middle of the year. Mentioned that he's receiving all this 10 99 income, and he's trying to understand what the S Corp can do for him. We would've created an [00:20:00] LLC at that time, converted it to an S corporation, fill out a new W nine form to provide to his, clients, right, and ask them to issue the 10 99 for this year.
Under this S corporation so that all of the income would now be underneath the S corp, and we would've started his payroll, or at least paid all of the payroll taxes due on the reasonable compensation that he would've taken as a W2 officer of his own company simply by calling us at the right time. A few months before that client may have saved a lot of money, unfortunately, by waiting too late and by not planning.
Here's what's going to happen. The client would essentially pay 15.3% on a hundred percent of the earnings that they made last year. That's unfortunate. So it's very important to know your deadlines and to make sure that you qualify and to start asking for your conversion before March 15th, or at the very least before the end of the year, so that you are in a position to [00:21:00] still make some adjustments.
Planning and Compliance Wrap Up
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Fabrice Metan: So one thing I don't want this to feel like is that I'm not trying to scare you away from becoming an S Corp. All I'm trying to do is to make sure that you understand all of the complexity that comes with the S corp and that you work with professionals who know what they're doing.
Right? Fairly simple. You gotta make sure that we understand the reasonable salary rules. We gotta make sure that we understand how to run payroll and what the payroll requirements will be. We have to make sure that we have some sort of quarterly tax planning, right? We love helping our clients with. You know, being proactive throughout the year, meeting quarterly, making sure we understand where your net earnings are and adjusting your reasonable compensation accordingly.
And of course, all of your new obligations once you become an S Corp, right? It's not going to be just your personal tax return. With one schedule included. Now you would have a separate business tax return. You would have payroll taxes being paid and payroll [00:22:00] tax forms submitted on a quarterly and annual basis, 9 41, 9 40 state unemployment taxes, federal unemployment tax.
So all of that, you need to make sure that you're working with the right professional to be able to help you, and hopefully this episode give you a little bit more insight. About what to do and when is the right time for you to become an S Corp. And if you're a 7, 6, 5 entrepreneur, you're definitely at that time and it's time for us to look at your situation and seeing how you can become an S Corp and save on taxes.
[00:23:00]