Choosing the Right Business Structure for Tax Efficiency
When you started woodworking professionally, business structure was probably the last thing on your mind. Most makers begin as sole proprietors by default—you sell things, you report the income, you pay taxes. Simple.
But as your business grows, that simple structure can cost you thousands of dollars in unnecessary taxes every year. Understanding when and how to change your business entity can put more money in your pocket while providing legal protections you don’t currently have.
Understanding Your Starting Point: Schedule C
If you operate as a sole proprietor, you report business income on Schedule C of your personal tax return. This is the default for any self-employed person who hasn’t formally created a different business entity.
How Schedule C taxes work:
- All net profit (revenue minus expenses) is subject to income tax at your personal rate
- All net profit is also subject to self-employment tax: 15.3% (covering Social Security and Medicare)
- There’s no distinction between money you take as salary versus money reinvested in the business
Example at $100,000 net profit:
- Self-employment tax: $14,130 (15.3% on 92.35% of profit)
- Income tax (assuming 22% effective rate): $22,000
- Total: approximately $36,130
The S-Corporation Advantage
An S-Corporation (S-Corp) is a tax election you make with an existing LLC or corporation. It allows you to split your income into two categories:
- Salary: Taxed as wages (subject to both income and payroll taxes)
- Distributions: Taxed as business income (subject to income tax but NOT self-employment tax)
The key insight: only your reasonable salary is subject to the 15.3% self-employment/payroll tax. Distributions escape that tax.
Example at $100,000 net profit with S-Corp:
Setting a reasonable salary of $50,000:
- Payroll taxes on $50,000 salary: $7,650
- Income tax on full $100,000 (22% effective): $22,000
- Total: approximately $29,650
Savings: approximately $6,480/year
What “Reasonable Salary” Means
The IRS requires S-Corp owners to pay themselves a “reasonable” salary before taking distributions. This is the key limitation—you can’t pay yourself $10,000 and take $90,000 as distributions.
Reasonable salary factors:
- What would you pay someone else to do your job?
- Industry standards for similar positions
- Your experience and skills
- Time and effort you put into the business
- Salary history if you’ve paid yourself before
For a custom woodworker generating $100,000-$200,000 in profit, a reasonable salary typically falls between $40,000-$80,000 depending on location and circumstances.
The Breakeven Point
S-Corp election adds costs:
- Annual tax preparation (more complex than Schedule C): $500-$1,500 additional
- Payroll processing and filings: $300-$600/year
- Registered agent fees (if required in your state): $50-$150/year
- State-specific fees (franchise taxes, annual reports): $0-$800/year
Total additional administrative costs: $1,000-$3,000/year
The general rule: S-Corp election makes sense when your net profit reaches $50,000-$60,000 annually. Below that, the tax savings don’t justify the administrative burden.
LLC vs. Corporation: Which Entity First?
S-Corp is a tax election, not a business entity. You first need either an LLC or a Corporation, then you elect S-Corp tax treatment with the IRS (Form 2553).
LLC electing S-Corp treatment (most common for woodworkers):
- Simple formation
- Flexible operating agreement
- Easier to dissolve if needed
- Familiar structure for small businesses
Corporation electing S-Corp treatment:
- More formal governance requirements
- Better suited for taking outside investment
- May be required for certain types of business relationships
- More complex to maintain
For most custom woodworkers, an LLC with S-Corp tax election provides the best combination of simplicity and tax efficiency.
The Qualified Business Income Deduction (QBI)
Under current tax law, many pass-through businesses (sole proprietorships, LLCs, S-Corps) qualify for a 20% deduction on qualified business income. This applies to most woodworking businesses.
However, the QBI deduction is limited for very high earners (above approximately $182,000 for singles, $364,000 for married filing jointly). At these income levels, the interplay between salary, distributions, and QBI deduction becomes complex—consult a tax professional.
Practical Considerations
Payroll Obligations
With S-Corp, you become your own employer. This means:
- Withholding income taxes and paying them quarterly
- Paying employer and employee portions of Social Security and Medicare
- Filing quarterly payroll tax returns (Form 941)
- Annual W-2 for yourself
Most woodworkers use a payroll service (Gusto, QuickBooks Payroll, Paychex) to handle these requirements. Cost: $30-$60/month for a one-person payroll.
Reasonable Salary Documentation
Keep records supporting your salary decision:
- Industry salary surveys for custom furniture makers
- Job listings for similar positions in your area
- Documentation of hours worked
- Any certifications or specialized skills
If the IRS challenges your salary as too low, they can reclassify distributions as wages and assess back taxes plus penalties.
Timing the Switch
S-Corp election must be filed within 75 days of the start of the tax year for the election to apply that year. Plan ahead—decide by mid-December to elect S-Corp treatment starting January 1.
Late elections are sometimes possible but require additional paperwork and IRS approval.
When Schedule C Still Makes Sense
S-Corp isn’t always the right answer:
- Net profit below $50,000: Administrative costs exceed tax savings
- Inconsistent income: If you’re paying yourself more in salary than you can afford during slow periods, you create cash flow problems
- Significant retirement contributions: Some retirement plan calculations are based on wages, not total income. Lowering wages to reduce SE tax might limit retirement contributions.
- Health insurance considerations: The rules for S-Corp owners deducting health insurance premiums are different than for sole proprietors
Working with a Tax Professional
This decision has long-term implications. Invest in proper advice:
- Find a CPA or tax advisor who works with small businesses and understands self-employment issues
- Ask specifically about S-Corp experience
- Request a multi-year tax projection showing Schedule C vs. S-Corp outcomes at your income level
- Discuss state-specific implications (some states have additional S-Corp taxes or don’t recognize the election)
The initial consultation ($200-$500) pays for itself many times over if you make the right decision.
Step-by-Step: Making the Switch
- Consult a tax professional to confirm S-Corp makes sense for your situation
- Form an LLC in your state (if you don’t already have one) – typically $50-$500 depending on state
- File Form 2553 with the IRS to elect S-Corp tax treatment
- Set up payroll for yourself
- Open a business bank account if you haven’t already (required for clean record-keeping)
- Establish accounting practices that separate salary from distributions
The Bottom Line
For woodworkers earning $60,000 or more in net profit, S-Corp election can save $5,000-$15,000 or more in taxes annually. The additional complexity is real but manageable with the right advisors and systems.
Run the numbers for your specific situation. If the savings are substantial, make the switch. If they’re marginal, stay simple with Schedule C until your business grows further.
Tax efficiency isn’t the most exciting part of running a woodworking business, but the thousands you save can fund new equipment, higher quality materials, or simply more money in your pocket. That’s worth an hour with a CPA.
