{"id":278,"date":"2012-10-10T09:45:05","date_gmt":"2012-10-10T17:45:05","guid":{"rendered":"http:\/\/blog.huddlestontaxcpas.com\/?p=278"},"modified":"2023-10-23T19:01:36","modified_gmt":"2023-10-24T03:01:36","slug":"small-business-webcast","status":"publish","type":"post","link":"https:\/\/huddlestontaxcpas.com\/blog\/small-business-webcast\/","title":{"rendered":"Small Business Webcast"},"content":{"rendered":"<p><a title=\"SBW\" href=\"http:\/\/www.smallbusinesswebcast.com\" target=\"_blank\" rel=\"noopener noreferrer\">Small Business Webcast<\/a> is a great place for people to come for free continuing education on several elements important to small business. Its mission is to promote the health and wealth of small business. One of the excellent resources the site has to offer is its recorded webcasts on a variety of helpful topics.<\/p>\n<p>Check out the webcast on reducing taxes through entity selection, LLCs &amp; S Corps Explained &#8211; Using them to Reduce Taxes, or read the transcript below if you prefer. Also, don&#8217;t forget to visit our <a title=\"Self-employed Tax Guide\" href=\"http:\/\/www.huddlestontaxcpas.com\/self-employed-tax-guide\/\" target=\"_blank\" rel=\"noopener noreferrer\">Self-employed Tax Guide<\/a>, which can be used as an excellent tax resource for people who are their own boss. Just a couple of the beneficial articles available:<\/p>\n<ul>\n<li><a title=\"Entity Choice\" href=\"http:\/\/www.huddlestontaxcpas.com\/entity-choice-s-corp-c-corp-llc\/\" target=\"_blank\" rel=\"noopener noreferrer\">Entity Choice (Saving with S Corporations)<\/a><\/li>\n<li><a title=\"Reasonable Compensation\" href=\"http:\/\/www.huddlestontaxcpas.com\/self-employed-tax-guide\/reasonable-compensation-for-s-corporation-owners-officers\/\" target=\"_blank\" rel=\"noopener noreferrer\">Reasonable Compensation for S Corporations Owners\/Officers<\/a><\/li>\n<\/ul>\n<p><strong>LLCs and S Corps Explained &#8211; Using them to Reduce Taxes &#8211; Transcript<\/strong>:<\/p>\n<p>This presentation will be on entity selection, and in particular the tax\u00a0advantage of whatever type of entity you want to use for your business. What we&#8217;re going to do today is we&#8217;re going to go through a similar set of examples, with each different type of entity. So, we&#8217;re going to make the same assumptions on all of them.<\/p>\n<p>Those assumptions are that this business has $100,000 of net income. We\u00a0have a new person coming in for the live webcast. Eric, have a seat. We&#8217;ll go through and look at all these examples, again, making the same\u00a0assumption, $100,000 of net business income. We&#8217;re going to assume that\u00a0the owner is in a 35% tax bracket, but doesn&#8217;t have any other self\u00a0employment or earned income.<\/p>\n<p>Here we go with the first slide.\u00a0We&#8217;re going to look at a C corporation.<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/0m6wtxXwT*6tatOVrVLCftkROSzL8KNopQqh0lo3ILz-DsPXkSiCxguVWqDIbR7XaP9jD*sPbJHkBldybh-d7qlv-yZfkoOh\/entityselectionpg1.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/0m6wtxXwT*6tatOVrVLCftkROSzL8KNopQqh0lo3ILz-DsPXkSiCxguVWqDIbR7XaP9jD*sPbJHkBldybh-d7qlv-yZfkoOh\/entityselectionpg1.png\" alt=\"\" width=\"287\" \/><\/a><\/p>\n<p>The C corporation has $100,000 of net income. C corporations, unlike other types of entities, pay their own tax. It&#8217;s a separate entity, and it pays its own tax. The tax rates start out fairly preferential for a C corporation. The first $50,000 is taxed at 15%. A C corporation with<\/p>\n<p>$100,000 profit you&#8217;re going to pay corporate income tax of $22,250. That&#8217;s\u00a0going to leave the corporation with $77, 250 in the corporate bank account.\u00a0The owner doesn&#8217;t yet have that money. It&#8217;s in the corporate bank account.<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/wUP*es1PHsTzKE*jWY9BlbbN*hgosBeNd*mHyq6QcwkNdV*yMteWFQI3ghh3UYuj3bhiuGEykv*Mn4heXFOxNyrDDHz79xxn\/entityselectionpg2.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/wUP*es1PHsTzKE*jWY9BlbbN*hgosBeNd*mHyq6QcwkNdV*yMteWFQI3ghh3UYuj3bhiuGEykv*Mn4heXFOxNyrDDHz79xxn\/entityselectionpg2.png\" alt=\"\" width=\"380\" \/><\/a><\/p>\n<div>\n<p>You may have heard of the double taxation you have with C corporations.<\/p>\n<p>That is, in fact, true. To get that money from the corporate bank account\u00a0to the owner&#8217;s bank account, there is tax involved in that. That payment is\u00a0a dividend. In this example, we have a dividend of $77,250 to the owner.<\/p>\n<p>That dividend is subject to income tax. Now, that income tax used to be,\u00a0before the Bush tax cuts, that dividend was taxed at our ordinary income\u00a0tax rate, which, about a decade ago, before the Bush tax cuts, was taxed at\u00a0the highest rate of 39.6%. Now you get that preferential dividend rate of\u00a015%. Keeping in mind, this is the second time this income has been taxed.<\/p>\n<p>The owner&#8217;s going to pay dividend tax of $11,588 on this. You started out\u00a0with $100,000 of earnings after paying all of your business expenses,\u00a0except taxes, and you are left with $65,662 to purchase groceries.<\/p>\n<div>\n<p>In the next example, we&#8217;re, again, going to look at a C corporation . . .<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/f1oqcDhDCt8dLEaoZ4T2Y0XovYqGemesXJsAfFg23x9YsxxchRZfbIXCMX6CawYWD5x3iQ*v8naxtZ8lLWeaIqyi14OwOyQi\/entityselectionpg3.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/f1oqcDhDCt8dLEaoZ4T2Y0XovYqGemesXJsAfFg23x9YsxxchRZfbIXCMX6CawYWD5x3iQ*v8naxtZ8lLWeaIqyi14OwOyQi\/entityselectionpg3.png\" alt=\"\" width=\"559\" \/><\/a><\/p>\n<p>but\u00a0we&#8217;re going to use a little bit different strategy in getting the earnings\u00a0to the owner. Instead of paying a dividend, we&#8217;re going to pay the owner a\u00a0wage. Now, we are not able to pay out the entire $100,000 as wage, because\u00a0there is employment taxes involved on the wages, of course. The most we\u00a0could pay out to the owner is $93,000. The rest of it has to be paid in\u00a0employment tax. There&#8217;s the $7,000 of\u00a0employment tax.<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/k9eKHbqOKuuhD6z16bK*71Zh2FDPNJRlMirUU2GHaxkUPEUoSjT9mXQCyADRsduBVwgcDHwFk8opE48XEf1Ra0*zmdZR3Dek\/entityselectionpg4.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/k9eKHbqOKuuhD6z16bK*71Zh2FDPNJRlMirUU2GHaxkUPEUoSjT9mXQCyADRsduBVwgcDHwFk8opE48XEf1Ra0*zmdZR3Dek\/entityselectionpg4.png\" alt=\"\" width=\"480\" \/><\/a><\/p>\n<p>Going to the next slide,\u00a0the owners got a wage of $93,000. We will use the\u00a0same assumption that they are in a 35% tax bracket. They are going to pay\u00a0individual income tax of $32,513. Now, just as the corporation had\u00a0employment taxes, you as an employee also have employment tax. All of us\u00a0that have W-2 jobs have Social Security and Medicare taken out of our wage.\u00a0That&#8217;s what makes up this additional $7,000 of employment tax. That leaves\u00a0this owner with $53,275 to purchase groceries. Remember, we started out\u00a0with $100,000 after all of our business expenses except for taxes, and this\u00a0is what we end up with.<\/p>\n<p>Going on to the next slide . . .<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/0m6wtxXwT*4PY01cPRxzXc*TzTSSjVin6a5b6R1md7e7yhFPGgEzPqCmBu9WGvUW429wyFg*7HgDks7*yKTHdgmWs477tLDH\/entityselectionpg5.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/0m6wtxXwT*4PY01cPRxzXc*TzTSSjVin6a5b6R1md7e7yhFPGgEzPqCmBu9WGvUW429wyFg*7HgDks7*yKTHdgmWs477tLDH\/entityselectionpg5.png?width=568\" alt=\"\" width=\"568\" \/><\/a><\/p>\n<p>I tend to march through this pretty fast, if you have questions feel free to pop in there in the chat box, and I&#8217;ll try to look over there once in a while, sometimes I miss it. Most often are sole proprietors, rather than any type of corporation. That&#8217;s what we&#8217;ll look at in this next example. Now, I don&#8217;t have a separate slide for an\u00a0LLC. The reason I don&#8217;t, is because a single member LLC that has not made an election to be taxed as something different is treated as a sole proprietor for tax purposes, because the LLC is a disregarded entity, as far as the IRS is concerned. This applies to a PLLC, also.<\/p>\n<p>This slide not only addresses the sole proprietor, but also addresses the LLC. Again, we&#8217;ll go through the same example except this time with a sole proprietor or an LLC. We start out with $100,000 of profit. We&#8217;re going to have individual income tax $32,527. The reason we don&#8217;t have $35,000 of income tax, remember they are in a 35% income tax bracket, is that half of yourself employment tax is deductible for determining your income tax.<\/p>\n<p>Also, we have self employment tax of $14,130. That&#8217;s going to leave this\u00a0person with $53,343 to purchase groceries or whatever they want. As you see by the slide, that tax burden is somewhat onerous, as you see by the man with the ball and chain at the bottom. One of the best ways that I&#8217;ve found of helping small businesses is getting out of this situation. Rather than paying that amount, and one of the big problems here is not the income tax.<\/p>\n<p>This person is in the 35% bracket, which means that they make a lot more money than just this $100,000. They have income from other sources.\u00a0The big meany here is this self employment tax, because that is 15.3% on top of that 35% income tax bracket. That&#8217;s a lot of what we deal with is attacking that self employment tax. One of the ways we do that is with an\u00a0S corporation.<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/oFeVtNrq5MnVNpfHqO-7dDsaI4blDnJC7HXqemAk*O7qR8Alk2XL1R9K0BADmOV1S6*s*K6o015gco-Sn4CUIn1pQzFuozgr\/entityselectionpg6.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/oFeVtNrq5MnVNpfHqO-7dDsaI4blDnJC7HXqemAk*O7qR8Alk2XL1R9K0BADmOV1S6*s*K6o015gco-Sn4CUIn1pQzFuozgr\/entityselectionpg6.png?width=335\" alt=\"\" width=\"335\" \/><\/a><\/p>\n<p>Now, let me add a little caveat here. I don&#8217;t want people to\u00a0come away from this presentation thinking that, &#8220;Oh, John Huddleston said\u00a0that an S corporation is the best type of entity, the most tax advantaged entity.&#8221; You can&#8217;t truthfully make a blanket statement like that because you have to look at all of your facts and circumstances and determine\u00a0what&#8217;s going to be best for you.<\/p>\n<p>I have found, through an S corporation, that I can reduce taxes for a lot of small business owners. Let&#8217;s go through this example. Again, we&#8217;ve got $100,000 of profit after our business expenses. Now, a S corporation is different from a C corporation. It is still a separate entity, but it&#8217;s different in the sense that it&#8217;s a flow-through. By flow-through, I mean all of the profits or losses flow-through to the owners. The S corporation rarely pays income tax.<\/p>\n<p>Rather, it&#8217;s the owners that pay the income tax on that income. You don&#8217;t have the double taxation that you have with a C corporation. Unlike the sole proprietor or the LLC, the profits of an S corporation are not subject to self employment tax. As we go through this, there&#8217;s $0.00 income tax at the corporate level, so $100,000 of profit after corporate tax.<\/p>\n<p>Going to the next slide, that money still has to get to the owner.<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/TcuUG8pxW1S*ZYD*JaKOcSSfNVd2Z-tjEP51oiks8UvKAv1RYpO2KMIrKCy2HjoHrjQAO5HodcaJyaw2jPIaMIbLm584ja3n\/entityselectionpg7.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/TcuUG8pxW1S*ZYD*JaKOcSSfNVd2Z-tjEP51oiks8UvKAv1RYpO2KMIrKCy2HjoHrjQAO5HodcaJyaw2jPIaMIbLm584ja3n\/entityselectionpg7.png\" alt=\"\" width=\"433\" \/><\/a><\/p>\n<p>Regardless of if it&#8217;s distributor or not, the owner is going to be taxed on this income, again, because it&#8217;s a flow-through. The owner, being in a 35% tax bracket, is going to pay $35,000 of individual income tax. That&#8217;s going to leave them with $65,000 to buy groceries.\u00a0That&#8217;s a better scenario than what we had back with the sole proprietor . . .<\/p>\n<div><a href=\"http:\/\/api.ning.com\/files\/jMJNA3WRhk5*KLvODU29dJnB3fCR6ARsjKX4oGiZeA5mXVkoAdIS3eA1iYmdFQOI6sGBIu7nCbkTRXSfQgMoV*K2JNpCJ85S\/entityselectionpg5.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/jMJNA3WRhk5*KLvODU29dJnB3fCR6ARsjKX4oGiZeA5mXVkoAdIS3eA1iYmdFQOI6sGBIu7nCbkTRXSfQgMoV*K2JNpCJ85S\/entityselectionpg5.png\" alt=\"\" width=\"568\" \/><\/a><\/div>\n<div>that was left with $53,000 to purchase groceries. We&#8217;ve saved $12,000 here.<\/div>\n<div>\n<p>Now, people might be thinking, &#8220;That&#8217;s still a lot of income tax.&#8221; But keep\u00a0in mind, this person is in that 35% income tax bracket. In order to lower\u00a0that, we&#8217;ve got to deal with this $100,000 figure, looking at how we can\u00a0reduce that. Perhaps through retirement plans and such, we can lower that\u00a0number.<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/XxS6ekofqL0lgocxVpN7kb33cLXcXvgn0A*0xP9byCeIG9nTCUW4OE9VV6BLvJAPjKKAChe1odPnhkRTegRBPTAxkTJhWfmv\/entityselectionpg7.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/XxS6ekofqL0lgocxVpN7kb33cLXcXvgn0A*0xP9byCeIG9nTCUW4OE9VV6BLvJAPjKKAChe1odPnhkRTegRBPTAxkTJhWfmv\/entityselectionpg7.png\" alt=\"\" width=\"433\" \/><\/a><\/p>\n<p>This person is in a high tax bracket. They have done better than the sole\u00a0proprietor and ended up with $65,000. The problem here is that this person\u00a0is working for this business. When you are working for your business, if\u00a0you&#8217;re an S corporation, you are required to pay yourself a reasonable\u00a0salary. That wasn&#8217;t done in this scenario. That&#8217;s the reason for this next\u00a0slide, which is a bit of an overstatement . . .<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/T6RCS6czGyL0l-ehjkS3JatbtBfol5J8SXxgjCpzpjyO9*GUdDT*0uXt9OU8U1KQdYVsk1qLOJdgt-wHwo-5yWu76GUHvQb5\/taxjail.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/T6RCS6czGyL0l-ehjkS3JatbtBfol5J8SXxgjCpzpjyO9*GUdDT*0uXt9OU8U1KQdYVsk1qLOJdgt-wHwo-5yWu76GUHvQb5\/taxjail.png\" alt=\"\" width=\"239\" \/><\/a><\/p>\n<p>you won&#8217;t actually go to jail,\u00a0but you will likely get audited, and you will likely not do well on that\u00a0audit.\u00a0When you complete an S corporation return, one of the first lines on the return says, &#8220;Officer compensation&#8221;. It&#8217;s right there on the front page,\u00a0what the owners are paid. You want some amount in that line, hopefully,\u00a0it&#8217;s a reasonable amount.<\/p>\n<div>\n<p><a href=\"http:\/\/api.ning.com\/files\/hb5aobwwsKFcjPoyIf3M9ehn-zwNSxGA5UnfJTVX8EMFJzEEJEcJs*zWXKSSguqDhdSQO8lcShdCRLSRypW3nFE0048TkZgT\/entityselectionpg8.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/hb5aobwwsKFcjPoyIf3M9ehn-zwNSxGA5UnfJTVX8EMFJzEEJEcJs*zWXKSSguqDhdSQO8lcShdCRLSRypW3nFE0048TkZgT\/entityselectionpg8.png\" alt=\"\" width=\"349\" \/><\/a><\/p>\n<p>If we pay out all of the profits as wage, we might as well not be an S corporation. If we pay out all of the profits as wage, we end up with the same slide we had before with the C corporation\u00a0that paid out everything to the owner as wage.<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/XxS6ekofqL3knxwcCNwnLi48M0dufa6yOwjhnomOcTSZPLqGNSJs9sU4IcdU7K6ncknWmuNKTmggZwP3B8N9Rw9DLNd5dY-T\/entityselectionpg3.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/XxS6ekofqL3knxwcCNwnLi48M0dufa6yOwjhnomOcTSZPLqGNSJs9sU4IcdU7K6ncknWmuNKTmggZwP3B8N9Rw9DLNd5dY-T\/entityselectionpg3.png\" alt=\"\" width=\"559\" \/><\/a><\/p>\n<p>We didn&#8217;t end up in a very\u00a0good situation there.<\/p>\n<\/div>\n<div>\n<p>That&#8217;s what we&#8217;ll look at with this next slide.<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/OfhHsuNkcw1CMh3Q8nn1j49to7SUPaUKxuq7t-sTUmd3eJ8FFwSak**uSYrmEW9GM1QRfHVHoqwe*PC2LENpujKArptJwbdu\/entityselectionpg8.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/OfhHsuNkcw1CMh3Q8nn1j49to7SUPaUKxuq7t-sTUmd3eJ8FFwSak**uSYrmEW9GM1QRfHVHoqwe*PC2LENpujKArptJwbdu\/entityselectionpg8.png\" alt=\"\" width=\"349\" \/><\/a><\/p>\n<p>We&#8217;ll look at an S\u00a0corporation that has $100,000 as profit and pays out a wage to the owner of\u00a0$20,000. Now, you might be thinking, &#8220;$20,000, that really doesn&#8217;t sound\u00a0like a reasonable wage. That&#8217;s aggressively low.&#8221; And, yeah, that very\u00a0likely could be.<\/p>\n<p>There are examples when that could be a reasonable wage. Maybe this owner\u00a0doesn&#8217;t work very many hours for this business. Maybe it is a very capital\u00a0intensive business. But, at any rate, we&#8217;re going to assume that this is a\u00a0reasonable wage. So, there is $0.00 corporate income tax, because S\u00a0corporations don&#8217;t pay income tax. There&#8217;s $1,500 of employment tax that\u00a0the corporation has to pay.<\/p>\n<div>\n<p>Going to the next slide . . .<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/RlofkH1plk3xv*HTv25pWG9-*T6mIPvawDaNgmVL4ljpuBem5meGc6Xdq3-yhkEa83dHJiTMmUKRw3yZiBHikFObM2EAnT5V\/entityselectionpg9.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/RlofkH1plk3xv*HTv25pWG9-*T6mIPvawDaNgmVL4ljpuBem5meGc6Xdq3-yhkEa83dHJiTMmUKRw3yZiBHikFObM2EAnT5V\/entityselectionpg9.png\" alt=\"\" width=\"504\" \/><\/a><\/p>\n<p>and that leaves us $78,000 that can flow-through to the owner. In addition to that, the owner is getting the $20,000 wage. Again, the owner is in the 35% tax bracket, they are going to pay $34,465\u00a0in income tax.<\/p>\n<div>\n<p>Also, just like all of us with W-2 jobs, they are going to have Social Security and Medicare withheld from their paycheck. They are going to pay employment tax on the employee side of $1,530. That&#8217;s going to leave this person with $52,475 to purchase groceries. So, we ended up about $9,000\u00a0better than the sole proprietor or the LLC in this example:<\/p>\n<div>\n<p><a href=\"http:\/\/api.ning.com\/files\/mMN2mYOOPRubpo*xOfUiJSEHXH-bVgmpE36cCfoP8ChGu-V2yxUWRfphJIrXERIzFi7KxjwruwIb1eYkDGkuGIex67X4GmEk\/entityselectionpg5.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/mMN2mYOOPRubpo*xOfUiJSEHXH-bVgmpE36cCfoP8ChGu-V2yxUWRfphJIrXERIzFi7KxjwruwIb1eYkDGkuGIex67X4GmEk\/entityselectionpg5.png\" alt=\"\" width=\"568\" \/><\/a><\/p>\n<p>Hopefully, you&#8217;ve got the picture that the way you save money with this is to have some amount of difference between the total profit and that reasonable salary amount.<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/nQC--rm6PHmSXgVJPtc8ZkdEfxZHIE9eHid**I0F8zn2pd-IkbXq75W1o90URMj-0ZNHu8lZc-h79Bhgn9tQUId1At7s5CZ9\/entityselectionpg10.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/nQC--rm6PHmSXgVJPtc8ZkdEfxZHIE9eHid**I0F8zn2pd-IkbXq75W1o90URMj-0ZNHu8lZc-h79Bhgn9tQUId1At7s5CZ9\/entityselectionpg10.png?width=750\" alt=\"\" width=\"750\" \/><\/a><\/p>\n<p>If there is a fair amount of spread between the\u00a0total profit and the reasonable salary, then you can make money on that\u00a0difference. You can save self employment tax on that difference.<\/p>\n<div>\n<p>The trick is to pay yourself the smallest amount possible but still have that be reasonable compensation. Everybody wants the formula for that, and there is no formula. You just have to look at all of the facts and circumstances. One of the things that you might look at, is where are those profits coming from? If the profits are coming from your capital investment, or if the profits are coming from the leverage that you have\u00a0from employees, that would suggest that there could be a greater allocation\u00a0towards profit and a light allocation towards salary.<\/p>\n<p>On the other hand, if there is no capital investment and there are no employees, you&#8217;re just being paid for your hours, that would suggest that almost all of the allocation should be towards salary. You might look at what it would cost to hire someone to do what you do. If you weren&#8217;t working for this business, you wouldn&#8217;t be required to pay yourself a\u00a0reasonable compensation.<\/p>\n<p>If you hired somebody else to do what you do for this business, what would it cost? How aggressive do you want to be with that number? Do you want to be conservative or do you want to be very aggressive and have a lower\u00a0salary?<\/p>\n<p>Again, all of the facts and circumstances go into this. The salary should be a reasonable amount, it should be paid regularly. It&#8217;s also a good idea to have minutes that will document your salary policy, backed up by some research. You could do some research at Salaries.com or some other place to help you come to your decision. Also, document that decision. If that&#8217;s documented contemporaneously, as opposed to doing all this research when you&#8217;re in an audit, it&#8217;s going to help. The IRS is more likely to respect your decision that was made back at that time. Those are some things to\u00a0look at.<\/p>\n<p>What some people do that have S corporations is, they don&#8217;t pay themselves\u00a0a salary throughout the year, then in December, they look at what their profit was and decide what it should be at that time. You can do that. There&#8217;s no requirement as far as when you have to pay your salary. That strategy is helpful in that you&#8217;ve delayed paying your employment tax an\u00a0entire year.<\/p>\n<p>If you take distributions throughout the year, you don&#8217;t have to pay employment taxes on those distributions. And then you pay out your salary all in December. Well, if you&#8217;re a monthly depositor, your employment taxes aren&#8217;t due until January 15th. You&#8217;ve deferred by a year, the obligation to\u00a0pay your employment taxes.<\/p>\n<p>But the problem is that if it&#8217;s all paid at the end of the year, it doesn&#8217;t look like a reasonable salary. I advise my clients to pay their salary on a regular basis, perhaps once a month. You can have a bonus amount at the end of the year, if you like. But, again, all of the facts and circumstances are considered in determining whether this is a reasonable salary. Best to\u00a0have it a regular amount.<\/p>\n<p>If it&#8217;s not a reasonable salary, what can the IRS do?<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/ZW6J7fNiKBolcQFf85UQ9cLwZfF-MoGDA8LiZQin1rjmuvG1ftXLgcPfIN9sMBMgyeoN4FxzHEhwUI5oIGqJA*hc4yJQc7eD\/entityselectionpg11.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/ZW6J7fNiKBolcQFf85UQ9cLwZfF-MoGDA8LiZQin1rjmuvG1ftXLgcPfIN9sMBMgyeoN4FxzHEhwUI5oIGqJA*hc4yJQc7eD\/entityselectionpg11.png\" alt=\"\" width=\"701\" \/><\/a><\/p>\n<p>Well, if you don&#8217;t make any distributions, there&#8217;s really nothing they can do. The IRS power is to relabel transactions. If you took an amount from your S corporation and you called it a profit distribution or you called it a loan to share\u00a0holder, the IRS has the power to relabel that transaction as salary. If they do that, then you are arguing with them about whether you are going to\u00a0have to pay penalties or not on that, because if it&#8217;s salary, you didn&#8217;t\u00a0pay the employment tax. Then, there are penalties on that, as well.<\/p>\n<p>If there are no distributions, there&#8217;s really nothing the IRS can do. They can&#8217;t create a transaction. If your salary is too small, you have an increased chance of audit and an increased chance of paying penalties on\u00a0that audit. I tried to come up with a way to illustrate this point . . .<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/sgq3YxP7vRIgbrvgDad2UFrG2wqCnT1KIQmsWixHq6sO8zxPyj7KKuIKDLzezY45AFYOZVxyfg746Y23xdQQ1n2wRbDtD2xg\/entityselectionpg12.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/sgq3YxP7vRIgbrvgDad2UFrG2wqCnT1KIQmsWixHq6sO8zxPyj7KKuIKDLzezY45AFYOZVxyfg746Y23xdQQ1n2wRbDtD2xg\/entityselectionpg12.png\" alt=\"\" width=\"569\" \/><\/a><\/p>\n<p>of the\u00a0reasonable salary, and there is a saying that&#8217;s been around for years, I didn&#8217;t come up with it, perhaps you&#8217;ve heard it before. The saying is, &#8220;That pigs get fed and that hogs get slaughtered.&#8221; The point being, if you&#8217;re just a little piggish, your salary is a bit less than the total profit, you can save some money, you can reduce your taxes that way. If you&#8217;re a hog and your salary is $0.00 or very close to $0.00, you&#8217;re going to get slaughtered, you&#8217;re going to get audited and you&#8217;re going to pay penalties on that audit.<\/p>\n<div>\n<p>This graph illustrates that saying. This blue line here represents your tax savings from having an S corporation. As this amount increases here, what we&#8217;re increasing as we go to the right is the amount that is distributed as profits as opposed to salary. If you distribute everything to yourself as profit and pay $0.00 salary, you&#8217;ve maximized your tax savings with the S corporation. If you pay everything out as salary and you have no profit distributions, then you have $0.00 tax savings from an S corporation. You\u00a0might as well be an LLC in that example.<\/p>\n<p>This blue line represents the tax savings from being an S corporation, notice that this line is linear. As you increase or decrease your salary or, actually, as this is illustrated increase or decrease the profit distribution, you will affect your audit risk. At this end, when we&#8217;re paying ourselves everything out as salary, we have minimized our audit risk. We always have some audit risk, so notice it&#8217;s not zero, but we&#8217;ve\u00a0minimized our audit risk there.<\/p>\n<p>As we increase the amount that we take as a profit distribution instead of as salary, you&#8217;ll notice that our audit risk goes up slightly. Until we get to this end of the graph, when our salary gets to be very small, we&#8217;re taking almost everything as profit distribution. You&#8217;ll notice that the audit risk not only is increasing, but is increasing at an increasing rate. It&#8217;s really skyrocketing at this end of the graph. This is not the place on\u00a0the graph you want to be.<\/p>\n<p>Yes, you&#8217;ve maximized your tax savings, but you may end up losing that, plus penalties on an audit. It&#8217;s much better to be in this part of the graph, where you tax savings exceed your audit risk. You&#8217;ve paid yourself a reasonable salary. That salary is not 100% of the profit, so you&#8217;ve saved\u00a0yourself some tax savings with the S corporation.<\/p>\n<p>The self employment tax is not the only thing to consider. You&#8217;ve got to take some other things into consideration. The home office deduction is not as inviting with an S corporation as it is with a C corporation, an LLC, or a sole proprietor. With an S corporation many CPAs end up taking it directly against the S corporation income, but the correct way to treat it\u00a0would be as an unreimbursed employee expense.<\/p>\n<p>That&#8217;s a miscellaneous itemized deduction, it&#8217;s only deductible to the extent it exceeds 2% of your adjusted gross income. If your adjusted gross income is $100,000, you&#8217;re going to lost $2,000 of that deduction. That&#8217;s not $2,000 of tax savings. It depends on what tax bracket you&#8217;re in. If you&#8217;re in a 25% tax bracket, $2,000 of deduction is going to represent $500\u00a0of tax savings or tax loss, in this example.<\/p>\n<p>The other thing is that the S corporation may represent more administration for you. If you are a sole proprietor or a single member LLC, as I mentioned before, that&#8217;s a disregarded entity as far as the IRS is concerned. Your activity is just included in schedule C of your return. If\u00a0you&#8217;re an S corporation, you have a separate income tax return to complete.<\/p>\n<p>Now, also if you don&#8217;t already have employees, becoming an S corporation and adopting this strategy means you&#8217;re going to become an employee of your company. So, now you&#8217;ve got payroll returns to complete. This doesn&#8217;t\u00a0really matter if you already have employees, all your administration is added by the first employee, so it&#8217;s not a big deal to add one more employee. If you don&#8217;t have employees, then that&#8217;s something you have to\u00a0consider. That&#8217;s extra administrative cost.<\/p>\n<p>There was some pending legislation to get rid of this tax loophole, you\u00a0might say. . .<\/p>\n<div>\n<p><a href=\"http:\/\/api.ning.com\/files\/sgq3YxP7vRJA57fEQDy6nFCsjLvJYLGXDEPFicyA6lyMSqFwYfJkRiAcOtfbGTLP7q6QwY867lAxcoDFx9UNAzdoWww5s4GZ\/entityselectionpg13.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/sgq3YxP7vRJA57fEQDy6nFCsjLvJYLGXDEPFicyA6lyMSqFwYfJkRiAcOtfbGTLP7q6QwY867lAxcoDFx9UNAzdoWww5s4GZ\/entityselectionpg13.png\" alt=\"\" width=\"648\" \/><\/a><\/p>\n<\/div>\n<p>The legislation failed. You can look at the statute and see why it failed. The way the statute was drafted, it was going to make the profits of S corporations subject to self employment tax, if the principle asset is the reputation and skill of three or fewer employees, and also, if it was in one of these industries. Well, that&#8217;s clearly an attack at small business. Small business is usually the good guy, so they decided to leave\u00a0this alone. It could come back in the future, though.<\/p>\n<p>The last two slides\u00a0are just the tax rates for corporate income tax and the married filing joint rates. In the next couple of days we will email a .pdf\u00a0of all of these slides to everybody, so you&#8217;ll have that.<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/hb5aobwwsKHYjvNdRUt415rEQWmKy9XsotIZ-n2kSZJ5p19P-bPcxUSh6Z8qzXG3B4glHLwGpQ1nFvrbDcUUQkAAF-hvEvOO\/entityselectionpg14.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/hb5aobwwsKHYjvNdRUt415rEQWmKy9XsotIZ-n2kSZJ5p19P-bPcxUSh6Z8qzXG3B4glHLwGpQ1nFvrbDcUUQkAAF-hvEvOO\/entityselectionpg14.png\" alt=\"\" width=\"656\" \/><\/a><\/p>\n<div>\n<p><a href=\"http:\/\/api.ning.com\/files\/R4DUg9yxfITwjTnqxrpKqw2LEbC2Mg3BK1*PmyvDsxloNDYGjsbnXzu*JgLhfU9cQeAn4WcgJvrj-SGXiG6q9xf0ImV-PvNo\/entityselectionpg15.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/R4DUg9yxfITwjTnqxrpKqw2LEbC2Mg3BK1*PmyvDsxloNDYGjsbnXzu*JgLhfU9cQeAn4WcgJvrj-SGXiG6q9xf0ImV-PvNo\/entityselectionpg15.png\" alt=\"\" width=\"708\" \/><\/a><\/p>\n<p>Any questions at this time?<\/p>\n<p>I&#8217;m sure there are things that I am forgetting. I guess maybe they&#8217;ll come to me, or someone will have a question about it. If there are no more questions, I&#8217;m sure someone will come up with a question as I&#8217;m wrapping this up, but I just want to point out that we&#8217;ve got webcasts coming up.<\/p>\n<p>I know one of the things I forgot about, it was our poll question.<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/b0eWVQfsIRMjg*p8VoftYZ3O-fFsCmtF*fb5j81MiCZZzz8hnq5KRofKJDydBRhl1rj6QOMkYJsliMT3ktMUwXMF9gAIr22M\/entityselectionpg16.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/b0eWVQfsIRMjg*p8VoftYZ3O-fFsCmtF*fb5j81MiCZZzz8hnq5KRofKJDydBRhl1rj6QOMkYJsliMT3ktMUwXMF9gAIr22M\/entityselectionpg16.png\" alt=\"\" width=\"258\" \/><\/a><\/p>\n<p>Some of you received a poll question in the past couple days. The poll question was\u00a0asking, &#8220;What do you think is the most tax friendly entity-type for small\u00a0business?&#8221; You can see the results here, we didn&#8217;t have too many people\u00a0vote, we only had five votes, but as always, the LLC was the leading vote\u00a0getter. Also, although we didn&#8217;t have many votes, the sole proprietorship\u00a0didn&#8217;t get any votes.<\/p>\n<p>Now I asked this same question on LinkedIn, and had 50 responses. The results were pretty similar. The LLC was the leading answer, and the sole proprietorship was the loser. Which is very interesting because the LLC, unless you make the election to be taxed as something different, if you&#8217;re a single member LLC for tax purposes you are a sole proprietor. So, it&#8217;s very interesting that the LLC is always the leading vote-getter for this question and the sole proprietor is always last. I&#8217;m not quite sure what the reason for that is, but perhaps your vote would be different now, after\u00a0the presentation.<\/p>\n<p>The other thing I forgot is that, if you have an LLC or a PLLC and you\u00a0watched this presentation and thought, &#8220;Well, I wish I would have become an\u00a0S corporation instead.&#8221; You don&#8217;t need to abandon your entity to create a\u00a0new S corporation. You can simply make an election with the IRS that your\u00a0LLC be taxed as an S corporation. You see, there&#8217;s no such thing as an LLC\u00a0tax return, so the IRS has to decide which category you fall in. By default\u00a0you&#8217;re one thing but you can elect to be something different. A single\u00a0member LLC is treated by default as a sole proprietor. If you have more\u00a0than one member and you&#8217;re an LLC you&#8217;re treated by default as a\u00a0partnership.<\/p>\n<div>\n<p>That&#8217;s another thing I forgot, people might think, &#8220;Well, I didn&#8217;t address the partnerships.&#8221; The slide regarding the LLC and the sole proprietorship really is the same slide for a partnership. Just figure if your share of the partnership&#8217;s profits is $100,000, your tax scenario is going to be the\u00a0same as that slide I showed with the sole proprietor. I&#8217;ll go back to it:<\/p>\n<p><a href=\"http:\/\/api.ning.com\/files\/XxS6ekofqL1CNC*cmqSsNCM4ZAut8pVLFN8lZpw4II3OIE*sWqkjIKhm0S5X6IthSw*0oUZFHjKrfGuKeZtYjCNrJ8PaHeXO\/entityselectionpg5.png\" target=\"_self\" rel=\"noopener noreferrer\"><img decoding=\"async\" src=\"http:\/\/api.ning.com\/files\/XxS6ekofqL1CNC*cmqSsNCM4ZAut8pVLFN8lZpw4II3OIE*sWqkjIKhm0S5X6IthSw*0oUZFHjKrfGuKeZtYjCNrJ8PaHeXO\/entityselectionpg5.png\" alt=\"\" width=\"568\" \/><\/a><\/p>\n<p>Again, LLC, sole proprietor and partnership: if your share of the partnership is $100,000 and you&#8217;re in the 35% tax bracket, you&#8217;re going to pay this amount of individual income tax, $32,527. All of those profits are subject to self employment tax. You are going to pay $14,000 in self\u00a0employment tax. You are going to end up with $53,000.<\/p>\n<p>I see Kathleen had a question,&#8221; What did you say about the home office\u00a0deduction and the best entity to use?&#8221; What I was saying, is that with the S corporation the home office is not as attractive. With a sole proprietor, a partnership, or an LLC, the home office deduction is deductible 100% against the profits of your sole proprietor, your LLC, your\u00a0partnership. That is not the case with an S corporation.<\/p>\n<p>With an S corporation that home office deduction is a miscellaneous itemized deduction. So, first of all, you have to itemize. People that itemize have a lot of mortgage interest or in other states they pay a lot of state income tax. Second of all, it&#8217;s a miscellaneous itemized deduction, which means you are going to lose the first 2% of your adjusted\u00a0gross income.<\/p>\n<p>It can work out fine with a C corporation because you can just end up renting to your C corporation, there&#8217;s no limitation there. It works out fine with a C corporation. It works out fine with an LLC, sole proprietor, and partnership. It&#8217;s not as good of a deduction with the S corporation. You have to weight that along with any potential self employment tax\u00a0savings that you have with an S corporation.<\/p>\n<p>Catherine is asking, &#8220;What is the deadline for the sub S election?&#8221; The deadline is March 15th, unfortunately. It has to be made in the first 75 days of creating the entity or the first 75 days of the tax year for which it is to apply. If you want it to apply for 2011, you are supposed to make that election by March 15th. Now, I&#8217;ve had some good success making a retroactive election. We have to show reasonable cause on why the election was not made, but the IRS tends to be fairly forgiving in making that\u00a0retroactive election. But, best to make it by March 15th.<\/p>\n<p>Michelle is asking, &#8220;What arrangement would you recommend for a free lance writer?&#8221; Well, for a free lance writer, I guess you&#8217;d have to look at, I&#8217;m\u00a0assuming you&#8217;re not going to have employees. I&#8217;m also assuming you&#8217;re not going to have a very significant capital investment. You&#8217;re going to need to take that into consideration when you decide what a reasonable wage would be. We&#8217;d have to take a look at what your total profit is going to\u00a0be, what you&#8217;re going to pay yourself as a reasonable wage.<\/p>\n<p>I never make that determination for the client. You really have to come up with that yourself, what a reasonable wage would be. It&#8217;s your industry. You know what people are paid in your industry. You know how aggressive you want to be, or how conservative you want to be with the IRS. We would have to look at that, and if there&#8217;s not enough difference between that reasonable wage and the total profit, then an S corporation is not going to work. On the other hand, if that reasonable wage can be a bit less than your total profit, then, yes, even as a free lance writer an S corporation\u00a0could have some tax savings for you.<\/p>\n<p>Phyllis is asking, &#8220;It is my understanding that if you live and work from a rent controlled apartment it is best not to claim home office deductions so you don&#8217;t lose the rent controlled apartment. I am in New York City.&#8221; I have no idea what the laws are with regard to maintaining the rent control\u00a0on your apartment, so I&#8217;m sorry I can&#8217;t help you with that.<\/p>\n<p>Michelle: Right no employees, right on the capital investment being fairly\u00a0low.<\/p>\n<p>Anne is asking, &#8220;What are the potential tax consequences of making an S corporation election several years after the formation as a C corporation?\u00a0What are the accounting steps?&#8221; There are some complicated issues here that have to be looked at. One of those has to do with the retained earnings of the C corporation. The IRS doesn&#8217;t want to lose out on that second level of tax. Remember with the C corporation, it paid tax and then it paid a dividend to the owner, and the owner was taxed again on that\u00a0income.<\/p>\n<p>Let&#8217;s say you have a C corporation and for years it was not paying you dividends, or at least not distributing all the retained earnings to the owner, so that this was building up. There&#8217;s an issue there if you were to make an election to be taxed as an S Corporation, the IRS wants to collect some of that money there. It is beyond the scope of this presentation to go into what that calculation is, but that&#8217;s definitely an issue. There&#8217;s going to be some tax consequences of doing that if you have retained\u00a0earnings built up in your C corporation. Also, there&#8217;s something called built in gains in your assets. That could create a taxable event for you if you make the conversion to an S corporation. Those are definitely things\u00a0you would want to consider.<\/p>\n<p>Again, if you find this helpful please tell your friends about this webcast, which is going to be presented again on May 18th. If you haven&#8217;t seen any of our other webcasts and you think those might be helpful, take a look at those. You can see them on the events page at smallbusinesswebcasts.com. We also have small business articles at smallbusinesswebcasts.com. After tax season is over, we&#8217;re going to start\u00a0adding those at a faster rate.<\/p>\n<p>My name is John Huddleston. I&#8217;m a CPA for Huddleston Tax CPAs here in Seattle. We help small businesses in the greater Seattle area and across the country in fact, with their tax issues. We do returns for all the states including your federal return. We help with payroll issues, book keeping, tax planning, tax preparation, small business evaluation. Whatever the tax and accounting needs are of small business owners are, that tends\u00a0to be what we do.<\/p>\n<p>I&#8217;d like to thank everybody for attending today. I don&#8217;t see any questions from the webcast attendees. We have a small live audience of three people. If you have any questions I&#8217;d be happy to answer them. If not, I&#8217;m going to\u00a0end the webcast. Have a good day.<\/p>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p>Small Business Webcast is a great place for people to come for free continuing education on several elements important to small business. Its mission is to promote the health and wealth of small business. One of the excellent resources the site has to offer is its recorded webcasts on a variety of helpful topics. Check [&hellip;]<\/p>\n","protected":false},"author":2,"featured_media":3708,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_genesis_hide_title":false,"_genesis_hide_breadcrumbs":false,"_genesis_hide_singular_image":false,"_genesis_hide_footer_widgets":false,"_genesis_custom_body_class":"","_genesis_custom_post_class":"","_genesis_layout":"","footnotes":""},"categories":[19],"tags":[],"class_list":{"0":"post-278","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-small-business","8":"entry"},"_links":{"self":[{"href":"https:\/\/huddlestontaxcpas.com\/wp-json\/wp\/v2\/posts\/278","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/huddlestontaxcpas.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/huddlestontaxcpas.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/huddlestontaxcpas.com\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/huddlestontaxcpas.com\/wp-json\/wp\/v2\/comments?post=278"}],"version-history":[{"count":3,"href":"https:\/\/huddlestontaxcpas.com\/wp-json\/wp\/v2\/posts\/278\/revisions"}],"predecessor-version":[{"id":6720,"href":"https:\/\/huddlestontaxcpas.com\/wp-json\/wp\/v2\/posts\/278\/revisions\/6720"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/huddlestontaxcpas.com\/wp-json\/wp\/v2\/media\/3708"}],"wp:attachment":[{"href":"https:\/\/huddlestontaxcpas.com\/wp-json\/wp\/v2\/media?parent=278"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/huddlestontaxcpas.com\/wp-json\/wp\/v2\/categories?post=278"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/huddlestontaxcpas.com\/wp-json\/wp\/v2\/tags?post=278"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}