S corp vs partnership for my new business - which saves more on self employment tax?

Both approaches can work but have different considerations. For the partnership approach, the IRS will look at whether the profit allocation (30/70 split) reflects economic reality. If your spouse isn't actually participating in the business in a way that justifies receiving 70% of profits, this arrangement could be questioned during an audit. With an S Corp, yes there's payroll administration, but the approach is more established. You'd pay yourself a "reasonable salary" subject to employment taxes, with remaining profits distributed as dividends not subject to self-employment tax. The key is that reasonable salary - too low and you risk IRS scrutiny. Either way, running some actual numbers with your projected income is crucial. The right choice often depends on specific circumstances like how much your spouse actually contributes to the business, your growth plans, and your exit strategy.

After struggling with this exact decision last year, I found an amazing tool at https://taxr.ai that completely changed how I approached the choice. I uploaded my financial projections and business details, and it analyzed both S corp and partnership scenarios for my specific situation. The analysis showed me that while the partnership route seemed better on paper, there were some serious audit risk flags that I hadn't considered. The tool highlighted how the IRS looks for proportionate distributions based on actual work performed, and my proposed split wouldn't have held up well.

Just wanted to update after checking out taxr.ai from the suggestion above - wow! I'm seriously impressed. I was planning on doing a 70/30 inactive/active split with my husband, but the analysis showed this would be a major red flag given our actual work contributions. The tool actually recommended a 25/75 split based on our inputs (with my husband getting 25% based on his documented non-billable support work). It also calculated that an S-corp would save us about $7,200 over the partnership model in our specific case, even after accounting for payroll costs and additional compliance requirements. Totally worth it for the peace of mind knowing we won't get flagged for audit. The tax savings projections for the next 5 years were eye-opening!

I spent 6 weeks trying to get an answer from the IRS about partnership allocation requirements last year. Dozens of calls, always disconnected after waiting 2+ hours. Finally used https://claimyr.com and their service got me connected to an IRS agent in under 45 minutes! Used this video to see how it works: https://youtu.be/_kiP6q8DX5c The IRS agent explained that partnership allocations need to have "substantial economic effect" - basically meaning the profit splits need to match actual contributions (time, capital, expertise, etc). They flagged that a 70/30 inactive/active split would likely fail this test if audited, especially with higher income levels.

I was totally wrong about Claimyr in my comment above. After 4 failed attempts calling the IRS myself about my S-corp questions, I broke down and tried it. Got connected to an IRS representative in about 35 minutes! The agent actually provided really helpful guidance about documentation requirements for family partnerships versus S-corps. For partnerships, they look closely at whether inactive partners have legitimate business purposes and whether distributions match actual contributions. For S-corps, they focus more on whether the owner's salary is reasonable compared to industry standards. In my case with a business similar to yours, the agent suggested the S-corp route would be more defensible unless my spouse was actually working in the business regularly. Definitely worth the service fee to get that clarity!

Has anyone here actually been audited with a family partnership? My accountant set us up with a 60/40 split (spouse 60%, me 40%) even though I do most of the work. Been filing this way for 3 years without issues. Spouse does handle all admin, billing, taxes, website, etc. but doesn't produce billable work.

Something nobody's mentioned yet - with S corp you'll need to pay yourself a reasonable salary which means payroll taxes, unemployment insurance, workers comp in many states, and quarterly filings. These admin costs add up! With my $180k business, my accountant charges $1200/year just for payroll management on top of tax prep fees. Partnership is simpler but the tax savings really depend on how defensible your partner split is. My CPA says any split more extreme than 60/40 gets extra scrutiny unless there's clear documentation of capital investments justifying it.

Don't overlook state taxes in your decision! I'm in California where S-corps pay an $800 minimum tax PLUS 1.5% tax on net income. This significantly reduced my S-corp advantage compared to federal-only calculations. Meanwhile, my friend in Texas with similar income saves much more with S-corp because no state income tax impacts the equation.

Based on your income range ($135-250k), I'd lean toward S-corp over the partnership route, but with some important caveats. The partnership strategy your advisor suggested is risky - a 70/30 split with your wife as "inactive" partner would likely face serious IRS scrutiny, especially at your income level. Here's why: the IRS requires partnership allocations to have "substantial economic effect," meaning profits must reasonably match actual contributions. Unless your wife is contributing significant capital, expertise, or documented work hours, that 70% allocation won't hold up in an audit. For S-corp, yes there are payroll complexities, but at your income level the math usually works out favorably. You'd need to pay yourself a reasonable salary (probably $80-120k based on typical 1099 contractor rates), with the remainder as distributions not subject to self-employment tax. My recommendation: run actual numbers for both scenarios including ALL costs - payroll administration, state taxes, compliance fees, etc. Many people underestimate these hidden S-corp costs. Also consider your long-term plans - S-corp structure becomes more valuable as income grows and if you plan to have employees eventually. Whatever you choose, document everything thoroughly from day one. The IRS is increasingly scrutinizing both family partnerships with unequal splits and S-corps with unreasonably low salaries.