YES! This is one of the most common mistakes and biggest red flags for IRS. A big tax advantage of starting an S-Corp is avoiding Self Employment Tax.
Let’s say that your business made $100,000 in 2021.
As a Sole Prop, you would pay approximate 15% or $15,000 in Self Employment Tax in addition to everything else.
As an S-Corp, you can pay yourself a ‘reasonable salary’ (normally 40 – 60% of your next income). This is subject to a similar tax through payroll. The rest of the income is passed through as a profit distribution. It avoids 15% Self Employment Tax. In the above case, if you salary was $50,000, the remaining $50,000 would avoid S/E tax saving you $7,500 annually.
Some S-Corps pay no salary to try and avoid all S/E tax. When the IRS finds out, they will subject all net income to S/E tax and penalties going back up to 7 year.
Save yourself the headache. Get on payroll!