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If you're a sole proprietor making 0,000 a year in profits or a partner in a partnership and your share of the profits equal 0,000, you might pay about ,000 in income taxes and about another ,000 in self-employment taxes.If you incorporate the business or reform it as a limited liability company and then elect to use the Subchapter S accounting rules, you will still pay the same ,000 in income taxes on the 0,000 of profits.
The Internal Revenue Code uses four tests to make this distinction: To prevent gamesmanship among related parties, Congress has added another layer of rules that must be analyzed to determine if a distribution is a redemption.Let's broach one other issue--the possibility that the Subchapter S tax accounting rules will be removed from the Internal Revenue Code. A couple of times in recent years (mostly seriously in 2010), Congress discussed the idea (see here, for example). Further, the "loophole" has been repeatedly discussed and then re-affirmed by Congress many times over the last half century. You and I should totally expect that politicians (both Republicans and Democrats) will continue to debate Subchapter S loophole regularly.But I will predict that just as they have done countless times in the past, they will in the end decide to continue the loophole they themselves created.But you will only pay self-employment taxes on the part of the profit you call "wages".If you call only ,000 of that 0,000 "wages," you will pay employment taxes not on the full 0,000 of profit but rather only on the ,000 of wages.