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Best entity to minimize self-employment tax

Asked by: Stacy - 26 April, 2011
I currently work as a graphic artist where I sell digital artist resources such as 3d models and textures and human character skins. I sell all of my products online. They are digital products and no tangible goods are exchanged. I am taxed as self employed which is a huge amount of taxes for me. I am looking for a way to alleviate this huge tax burden and was told that an S corporation was the way to go. I am the only partner in this "business".What are my best options in this situation in order to avoid paying such a huge amount of self employment taxes? Is there some option that is better than an S corporation? Also I am in California if that makes a difference though my business is all conducted online through a third party brokerage.
Answered by: Alex Zehn - 26 April, 2011
Dear Stacy,

On tax-related questions, such as this, it would serve you well to consult an accountant.

Although we are not accountants, we can offer you some general knowledge on the subject. What you are most concerned about is the self-employment tax. If you were to form an LLC, because you would be the single-owner, the IRS would treat your company as a "pass-through" entity. Meaning the company's income would be accounted for on your personal tax returns. With this setup, you would still be subject to the roughly 15% self-employment tax.

On the other hand, if you form an S-Corporation, what you can do is pay yourself a reasonable salary (that cannot be too small), pay the payroll taxes on that salary and distribute the remaining company income without being subject to the employment tax. The big caveat here is that you will have to do a serious amount of paperwork in order to pay the payroll tax on your salary. Payroll tax is a pay-as-you-go tax that must be paid to the IRS regularly throughout the year. It has to be paid on time, or you will incur interest and penalties. If you hire someone to do that for you, consider that your expenses may overshadow your savings.

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