Should You Hire a Contractor or Employee: A Guide for Small Business Owners

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Are self-employment taxes eating into your profits? If you’re running a growing business and filing taxes as a sole proprietor using Schedule C, you might be paying more than your fair share. While this approach works for newer or smaller businesses, it can quickly become inefficient as your revenue increases.

Fortunately, there’s a solution: restructuring your business and electing S-Corp status. By making the switch, you can reduce your tax burden, take advantage of optimized payroll strategies, and set your business up for growth. Partnering with an experienced Austin accounting firm like Insogna CPA can help you every step of the way.

💡 The Problem: Why Schedule C Stops Working as You Grow

Filing as a sole proprietor has its advantages—it’s simple, requires minimal setup, and allows you to report income and expenses directly on your personal tax return (Schedule C). But as your profits increase, so do your tax obligations.

Here’s why:

  1. 💡 High Self-Employment Taxes: Sole proprietors pay 15.3% in self-employment taxes (Social Security and Medicare) on all net profits, even if you don’t withdraw them for personal use.
  2. 💡 No Separation of Income: Your business income is taxed entirely as personal income, limiting your ability to optimize how you pay yourself.
  3. 💡 Missed Opportunities for Tax Efficiency: You may lose out on key deductions and benefits available to business owners with a more strategic structure.

If you’re earning $40,000–$50,000 or more in net profits, these inefficiencies could be costing you thousands every year. A local Austin small business accountant can help identify these pain points and propose tailored solutions.

The Solution: Electing S-Corp Status

Switching to an S-Corp allows you to retain the pass-through taxation of a sole proprietorship but introduces important tax-saving benefits. Here’s how it works:

1. Split Income into Salary and Distributions

With an S-Corp, your income is divided into:

  • Salary: Subject to Social Security and Medicare taxes.
  • Distributions: Exempt from self-employment taxes.

This simple adjustment can significantly lower your tax liability.

Example:

  • Schedule C filer with $120,000 in net profits pays $18,360 in self-employment taxes.
  • As an S-Corp, you take a $60,000 salary and $60,000 as distributions. Taxes apply only to the salary portion, saving $9,180 annually.

Partnering with a tax accountant in Austin ensures your salary and distributions comply with IRS rules.

2. Optimize Payroll Management

S-Corp owners must pay themselves a “reasonable salary,” which is subject to payroll taxes. This creates a clear distinction between personal and business income while ensuring compliance with IRS regulations. Austin’s accounting services, like those offered by Insogna CPA, can simplify payroll management.

3. Unlock Additional Tax Benefits

Electing S-Corp status opens the door to deductions for:

  • 📌 Health insurance premiums.
  • 📌 Retirement contributions (e.g., SEP-IRA or Solo 401(k)).

These savings can add up over time, further reducing your tax burden and supporting long-term financial goals. Contact a trusted CPA in Austin, Texas, for guidance.

Is It Time to Make the Switch?

Not every business is ready to transition from Schedule C to S-Corp. Here’s how to determine if the timing is right for you:

1. Profitability

Are your net profits consistently exceeding $40,000–$50,000 annually? If so, the potential tax savings can outweigh the additional administrative costs. An accounting firm in Austin can analyze your financials to confirm your readiness.

2. Ability to Pay a Reasonable Salary

Can your business comfortably support a fair, market-rate salary for yourself while maintaining profitability? This is essential for compliance with IRS rules.

3. Growth Goals

If you’re planning to scale, hire employees, or seek investors, transitioning to an S-Corp can enhance your business’s professional image and operational structure. Work with an Austin TX CPA firm to align your tax strategy with growth objectives.

Step-by-Step: How to Transition to an S-Corp

Ready to make the switch? Here’s how:

  1. 1️⃣ Form a Legal Entity:
     If you’re currently a sole proprietor, you’ll need to form an LLC or corporation before electing S-Corp status. Consult top accounting firms in Texas to ensure compliance.
  2. 2️⃣ File Form 2553 with the IRS:
     Submit this form to elect S-Corp status. Timing is key—you must file within 75 days of forming your business or the start of a new tax year.
  3. 3️⃣ Set Up Payroll:
     Establish a payroll system to pay yourself a reasonable salary. A trusted CPA South Austin professional can handle payroll taxes and compliance.
  4. 4️⃣ Separate Business Finances:
     Implement accounting software like QuickBooks or Xero to track income and expenses. Work with an Austin accounting service to ensure accuracy.
  5. 5️⃣ Consult a Tax Advisor:
     Partner with a knowledgeable tax advisor in Austin to optimize your tax strategy and avoid IRS penalties.

Real-World Example: How an S-Corp Transformed a Business

The Challenge:
 A freelance graphic designer earning $90,000 annually was struggling with high self-employment taxes and limited options for reinvestment.

The Solution:
 Insogna CPA recommends forming an LLC and electing S-Corp status. By designating $45,000 as salary and $45,000 as distributions, the designer can reduce their self-employment taxes by $6,885 in the first year.

The Outcome:

  • 📌 Significant tax savings.
  • 📌Simplified payroll and accounting systems.
  • 📌Funds reinvested into software and marketing, boosting annual revenue by 25%.

Why Choose Insogna CPA?

Transitioning to an S-Corp is a strategic move—but it requires expert guidance to get it right. Insogna CPA, one of the best CPA firms in Austin, specializes in helping small business owners make tax-efficient decisions that support growth.

Our services include:

  • ✅ Personalized evaluations to determine if S-Corp status is right for you.
  • ✅ Seamless filing and compliance assistance.
  • ✅ Ongoing support for payroll, tax planning, and financial management.

Let our team of experienced professionals, backed by top-notch Austin accounting services, guide you every step of the way.

Take the Next Step 👣

Switching from Schedule C to S-Corp can deliver significant financial benefits, but timing and execution are critical. With expert help from Insogna CPA, you can reduce your tax burden, streamline payroll, and position your business for long-term success.

Contact us today to schedule a consultation and learn how to make your business work smarter, not harder.

Charlotte Adams