Posted on September 20, 2015May 31, 2016 by Jan Roberg

Should Your LLC Be an S Corporation?

If your small business has reached the point where your self employment taxes are really hurting you, choosing an S Corporation status might be the answer to your problem.

If you own a single member LLC, the IRS considers that to be a “disregarded entity.” That basically means there’s no such thing as an LLC tax return. So, if you don’t make an “election” to taxed some other way, you’re taxed as a sole proprietor on your 1040 personal tax return. That means, you not only pay income tax on your LLC income, you also pay self employment tax on top of it. Ouch!

But as a disregarded entity, you may make an election to be taxed as an S corporation (or even a C corporation if you want to) instead of being a sole proprietor. So how do you know you might be ready to be an S Corp? Here’s my top three criteria:

1. Steady net income. If you have a loss on your business, that business loss can offset your other income on your tax return. One of the big benefits of an S corp is to reduce your self employment tax. If your business has a loss, you’re not paying self employment tax anyway so the S corp status wouldn’t provide much benefit there. A good rule of thumb, but certainly not a deal breaker, is to have a net income of about $50,000 to make the tax savings be greater than the additional cost of separate tax returns and payroll expenses. I work with business that have losses and still are S Corps. The $50K income isn’t a requirement, it’s just sort of a break even point on costs.

2. Separate Employer Identification Number (EIN) and bank account. If your business is set up as an LLC, you should have a separate EIN and a bank account for your business already. I’m always surprised by people who skip this step, but it’s important. You can get an EIN number for free, online. It takes about 5 minutes.

Learn more here.

And you really need a separate bank account. You don’t want to co-mingle your business funds with your personal money.

3. Discipline to make monthly payroll deposits and quarterly reporting. One of the requirements of an S Corporation is that the owner has to pay him or herself a reasonable wage. That means, even if nobody else works for you, you still need to write yourself a paycheck and pay yourself like an employee. If you’re already making your quarterly estimated tax payments–you’re probably able to handle doing a payroll. If you’re scrambling every year, you can’t keep on schedule etc, then I say don’t do the S corp. Not being up to date on your estimated payments can be a problem, but the IRS can get really nasty if you’re behind on payroll tax deposits.

If you have no discipline, and your business easily has enough revenue to handle the payments–and still want to do the S Corp, then pay the extra money to hire a payroll company to do it for you.

Setting a reasonable wage is usually the most difficult thing to determine. You want to go by what a person in your line of work would get normally get paid, that’s not always easy to figure. You should probably have your wage be at least 1/3 of your net income unless you can document that people in your line of work usually make less.

Now, these are just my guidelines. There’s really no “set in stone” criteria for S Corp status. And really, before you make any change to the status of your business, what you really should do is run the numbers. Sit down with your tax professional and – using the most recent tax return – run the business numbers as if you were an S Corp, a C Corp, and as a sole proprietor. Don’t forget to include the costs of your payroll taxes when running the numbers.

Everybody’s situation is a little different. Compare your numbers side by see to see if changing to an S Corporation makes sense for your small business. That’s really the best way to tell.

Posted on December 10, 2013May 31, 2016 by Jan Roberg

Tax Planning Strategy for High Income Earners with S-Corporations

Are you a high income individual with an S-Corporation? Photo by Jacob Bøtter at Flickr.com

Whenever I’m talking about tax strategies for high income earners with my clients they always ask, “What do you mean by high income?” If I’m talking to a person face to face and I bring up tax strategies for high income earners, I mean the person I‘m talking to. I wouldn’t bring it up otherwise. Since you happen to be reading this on the internet, for this post I generally mean people with incomes over $200,000.

Here’s what’s up: The new Medicare tax on investment income (or Obamacare tax, Net Investment Income tax, Healthcare tax, or whatever you want to call it) also taxes your S Corporation profits. Let that sink in for a minute. S Corporation profits will be counted in the same category as interest and dividends and capital gains for the 3.8% Medicare investment tax.

Let me give you an example of how this could affect you: Let’s say you’re single and you have wages of $150,000 and S-Corp profits of $200,000 for a total of $350,000 in Adjusted Gross Income.

To figure the medicare investment tax you’d take $350,000 – 200,000 (the base) = $150,000. You have $200,000 in investment income, you’re only going to pay the 3.8% on whatever is over the base so your Medicare investment tax is 3.8% time $150,000 which equals $5,700.

At $150,000 on wages, you’ve already maxed out the Social Security withholding that you were subject to so additional Social Security tax doesn’t affect this example.

Now let’s compare your investment Medicare tax with your wage Medicare tax. Withholding on your wages is 1.45%, plus the employer contribution on your wages is an additional 1.45%–so as the owner/employee of your S-Corp you’re paying 2.9% Medicare taxes on your wages. Once you cross the $200,000 wage point, there’s an additional 0.9% Medicare wage tax bringing the Medicare wage tax to 3.8%. That’s the same rate as you would pay with the Medicare Investment tax.

It used to be that one of the benefits of being an S-Corporation was that you didn’t pay the extra 2.9% (now 3.8%) Medicare tax. You’re losing the savings benefit you used to have.

Now this doesn’t affect everybody. If your S-Corp income is lower, this might not matter to you. That’s why you have to do some comparisons.

So, a really important question for you is going to be–is your S Corporation still the right business structure for you? For some people, the answer will be yes. For others, it might be time to convert to a regular C Corporation, a Sole Proprietorship, or Partnership.

The Obamacare tax will be reported on Form 8690 and added to your 1040 personal income tax return.

How can you tell? This year, more than any other year, you want to get your taxes done on time. Run the numbers all the ways that you’re thinking about. Be sure to figure things based on the changes you’d make if you had a different business structure. Then you can make an informed decision based on the numbers.

Remember, your corporation taxes are due by March 15^th. If you want to revoke your S-Corp election for 2014, you have to do that by March 15^th of 2014 otherwise it will be too late. Of course, you can revoke your S-Corp election and still file an extension for your 2013 taxes. But the smart thing is to run your numbers before you revoke the election–because you still might be better off keeping your S-Corp. For many companies, changing your corporate status will give you no benefit–for many others it will. That’s why it’s so important to make the decision with your eyes wide open and with all the facts in your hand.

Posted on September 24, 2013January 14, 2017 by Jan Roberg

Small Business Expenses: Advertising vs. Charity (Purple Pig Purchases)

Purple-Pig

At first blush, you might think that advertising and charity don’t go together at all. But when you own a small business, your advertising and charity might just go hand in hand. Let me explain.

When you own a small business, you’ll get lots of calls from organizations wanting your business to make donations to charities. When you’re a sole proprietor, partnership, or S Corporation, your charitable donations don’t reduce your business income, they only count as a charity donation on your Schedule A personal tax return.

So—let’s say you want to donate $100 to Cystic Fibrosis from your business. That’s all fine and good, but that donation doesn’t reduce your business income by $100. It doesn’t reduce your business income by anything at all. You still get to deduct it on your Schedule A—but if you don’t itemize your deductions, that $100 donation doesn’t help your tax return at all.

This is where advertising comes in. Instead of just donating $100 to a charity, you can buy an ad in a charity event program, that way you’re giving money to the charity, and getting a 100% business write-off for the advertising. The charity still gets your money, and you get a better write-off.

Why do you want to your business donation to be advertising? The taxes! If you have a sole proprietorship and you’re in the 25% tax bracket, your business income is actually taxed at 40.3%. (25% regular tax rate plus 15.3% self employment tax.) If you itemize your deductions, your $100 donation would really only cost you $75 (but only if you can itemize your donations.) But if you can count it as a business expense, then your $100 donation would really only cost you $59.70. ($100 minus $40.30) See why this is a good thing?

Of course, there are some things that are just going to be charitable donations no matter how you try to align them. Your tithe or temple dues simply won’t count as advertising. But when you’re looking at charities that you like to support, be sure to check out the advertising opportunities.

So what’s with the purple pig? A not for profit I support held an event for kids. Instead of just donating money, I got to set up a booth and hand out my fliers to the parents. The pig was part of a pig race game for the kids. The pig is a 100% deductible business expense—and he’s really cute. Cute and deductible—that works for me.