In USA, can I set up a one-person corporation and pay myself mainly through dividends?

Question

In the UK an IT-contractor can save in taxes by opening a company, paying themselves a minimum wage as a salary and then taking a larger amount of income as dividends.

1. Is this possible (for a single-person corporation) in the United States?
2. If yes, what company form would it require?
3. What would be the tax consequences? If it is necessary to limit this to a particular state, I live in Florida.

Answer 1

Is this possible (for a single-person corporation) in United States?

Yes, but if the salary you pay yourself is too low then you risk getting flagged for not providing yourself with reasonable compensation. A lot of resources recommend you that you pay yourself partially in dividends to avoid some taxes, as you mentioned is possible in the UK. However if you report no income you will probably be flagged by the IRS triggering an inquiry, audit, and potentially owe back taxes.

If yes, what company form would it require?

This is possible by organization your business into an S Corporation. The linked IRS site contains the necessary forms and instructions to register as such.

What would be the tax consequences?

Generally, you pay employer taxes and employee taxes on your salary but only pay employee income taxes on distributions. Some states (such as California) put extra taxes on S Corporations which may reduce some savings, though Florida's page on S Corporations does not mention any additional taxes. There are also filing and accounting costs associated with registering as an S Corporation. This could cost you around $100.

Answer 2

Single proprietorships, even if they are incorporated as a limited-liability corporation (LLC), and especially those in which the proprietor is the sole employee, are usually treated as pass-through entities by the IRS, and any "dividends" paid by the LLC to its sole shareholder are deemed to be self-employment income for the proprietor, and not dividends at all. For example, the IRS says

And an LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes), unless it files Form 8832 and affirmatively elects to be treated as a corporation.

That being said, many people do try running an LLC as a corporation (without ever filing Form 8832) for many years before the IRS finally catches on.

Answer 3

Sometimes an example is worth a thousand words. Let's compare a Sole Proprietorship to an S-Corporation that profits $100K a year:

As a Sole Proprietor with $100K in income (after expenses):

• Self Employment taxes (FICA) 15.3% = $15,300
• Note you can deduct the employer portion of FICA ($7650), so your newly adjusted income is $92,350.
• Federal Tax on $92,350 for 2017 (graduated up to 28%) = $18,839.75
• Total Tax Paid = $34,139.75

As an S-Corporation with $100K in income (after expenses):

1. You must choose a reasonable salary. Let's say you decide on $55K.
2. FICA taxes are only paid on wages, so 15.3% of $55K = $8,415
3. The employer portion of FICA is $4207.50 so your company income is $100K - ($55K + $4207.50) = $40,792.50 This is the amount that will be reported on your K1 and passed through to you.
4. Your adjusted income is $55K + $40,792.50 = $95,792.50
5. Federal Tax on $95,792.50 for 2017 (graduated up to 28%) = $19,803.65
6. Total Tax Paid = $28,218.65

Summary: forming an S-Corp instead of a Sole Proprietorship where you have $100K in income and you decide to pay yourself a salary of $55K, will save you $5,921.10 in taxes.

Important Notes:

1. The lower the salary you choose, the more you save on FICA taxes, but the salary you choose must be "reasonable".
2. With the S-Corp, you will have $40,792.50 available to take as a distribution, but you will pay the same amount in taxes whether you distribute all, some, or none of it. The taxes are based solely on the income; distributions do not affect your tax burden. (With the exception of if you distribute more than you have in income, you will pay capital gains.)
3. There are some extra expenses associated with having an S-Corporation, but they are certainly less than $6K/year.