Let’s say you currently run your small business as a partnership or as an LLC that’s treated as a partnership for federal tax purposes.

(In this analysis, we will refer to both of these ways of doing business as partnerships, because the partnership federal income tax rules apply to both.)

Let’s say you’re considering converting your partnership into an S corporation. The reason might be to reduce exposure for you and the other owners to Social Security and Medicare taxes, which come in the form of the self-employment tax for partners.

Specifically, each partner’s share of net partnership income is usually fully exposed to the self-employment tax. For 2022, the self-employment tax rate is a painful 15.3 percent on the first $147,000 of net self-employment income. On net self-employment income above $147,000, the self-employment tax rate drops to 2.9 percent.

For a shareholder-employee of an S corporation, the Social Security and Medicare taxes come in the form of the FICA tax. But for shareholder-employees, the FICA tax hits only amounts paid as salaries. Distributions of the remaining corporate cash flow are FICA-tax-free.

Whatever the reason for wanting to convert your partnership into an S corporation, here’s an explanation and a ... Log in to view full article.