If you are an active real estate flipper or wholesaler, you are more than likely subject to the self-employment tax (15.3%). Read on to discover how you can save thousands on your tax bill by electing to be taxed as an S Corp. A flipping or wholesaling business is not considered to be a passive activity like rental real estate. Instead it is considered an active business. And because flipping and wholesaling are active businesses, you are subject to the full 15.3% self-employment tax which can lead up to an $18,130.50 $21,068.10 (updated for 2020) tax on your earnings, ouch! You can definitely find a better use for that money, right? How Can Being Taxed as an S-Corp Help? Creating an S-Corp, or an LLC taxed as an S-Corp allows you to hire yourself as a W-2 employee and split your earnings between salary and distributions. In this strategy, you only pay the 15.3% SE tax on the part of your income considered salary, and not on the distributions. It is important to note that the wage or salary you pay yourself must be reasonable, otherwise the IRS might charge you back taxes and penalties (i.e. your wages can’t be $1 and dividends $99,999). Example You are a real estate flipper with earnings of $167,830 for the 2018 tax year. If you are simply a sole proprietor (or partner), then all of your flipping income is considered active, and up to $118,500 would be subject to the 15.3% SE tax – totaling $18,130.50. However, if you set up an LLC and elect to be taxed as an S-Corp, you can split the earnings between salary and distributions. With the help of a CPA, you determine $65,000 to be a reasonable salary. This means you will only pay the SE tax on $65,000, saving $8,361. Potential Pitfalls of this Tax Strategy Of course, Uncle Sam wants his money, so it’s never that easy. Service companies are more likely to be scrutinized by the IRS when using this strategy because most of their earnings come from personal efforts, and not of that of other employees. That is why it is imperative to work with a CPA to research and document the reasons behind the reasonable salary you decide to pay yourself. Also, the IRS requires companies with W-2 employees to pay Federal Unemployment Tax (FUTA) of 6.20% on the first $7,000 of income for each employee. In some states you could also be subject to the State Unemployment Tax (SUTA). Once you implement this strategy, you will be considered a W-2 employee and will have to pay this tax. There are also costs involved in creating the entity and filing a separate tax return if you’re not already a partnership. And for S Corps, there are some administrative requirements such as setting up a board of directors and holding meetings. The Bottom Line with S-Corp Taxes Creating an entity and having it taxed as an S Corp has its advantages and can potentially lower your tax liability, but may not be for everyone. There are costs involved with setting up and maintaining the entity, which will have to be weighed against the actual tax savings you will receive. In many cases this strategy will make sense for higher income earners (people earning at least $50,000 from their business). You will want to discuss the advantages and disadvantages of this strategy with your CPA to find out if this makes sense for you based on your personal circumstances. There are always unique circumstances, such as a husband-and-wife business (sole proprietor or partnership). You may also be interested in our article, “How To Take Money Out Of Your S Corp.” About the author: Thomas Castelli, CPA is a Tax Strategist and real estate investor, who helps other real estate investors keep more of their hard-earned dollars in their pockets and out of the government’s. You can find more articles from Thomas by visiting The Real Estate CPA’s website.