Posted on November 1, 2015May 31, 2016 by Jan Roberg

S Corporation – Computing the Tax Savings

When deciding if you should elect Sub-chapter S corporation status for your company, you need to run the numbers first!

Electing to be taxed as a Subchapter S Corporation instead of as a Sole Proprietor could mean big tax savings for you as a small business owner. Notice I said could–because it’s not always the case. It’s really important to run the numbers – all the numbers – and do a comparison so you can make an informed decision.

This post is going to be a little technical. I apologize for that up front. I’m going to try to keep it in plain English though, because even if you can’t run the numbers yourself, you need to see what I’m talking about so you can discuss this with your accountant.

Here’s an example where I think choosing to be a Sub S Corporation is the right choice for a business owner: Jack Sparrow is a single, self employed pirate with net self-employment income of $100,000. (Yes, Johnny Depp was on TV last night.) Jack has no other income to report on his tax return.

I ran the numbers for 2014 and it shows the total tax on the 1040 return to be $30,680. ($16,550 for the income tax and $14,130 for the self employment tax.)

That’s a lot of taxes!

But what if Jack were to set up a Sub Chapter S Corporation? He’d have to set himself up to receive payroll–(that’s part of the deal with an S Corporation, you have to pay yourself a salary) but the rest of his income would be taxed at his regular tax rate (they call that ordinary income) instead of at the self employment rate.

So for my example, I set Jack up with a payroll of $40,000, his S Corp income is $56,340 (not $60,000 because he’s paying some payroll taxes that are deducted.) So when I run the taxes for that, I’m showing that his total tax on his 1040 is $17,400.

Right here you’re probably going, “$13,280 in tax savings per year? Awesome! Sign me up now!”

But it’s not that simple. Because remember, part of being an S Corporation means that you must set up a salary for yourself and pay the payroll taxes. If you don’t include the cost of those payroll taxes in your calculations, you’re not giving yourself a true comparison of the total tax cost.

For Jack’s example, we set up a payroll for $40,000. From his $40,000, Jack will have $3,060 withheld as his employee share of FICA-that’s the Social Security and Medicare tax that gets withheld from everyone’s wages. Also, remember when I said his S Corp income was $56,340 instead of $60,000? That’s because as an employer, Jack also had to pay an additional $3,060 for the employer’s share of FICA, and I added another $600 for state and federal unemployment taxes. The unemployment tax will vary by state but $600 is a reasonable estimate.

When you add those payroll tax costs to the 1040 tax cost, Jack’s total S Corp taxes are now $24,1120. That’s still a big tax savings of $6,650! In this case, of course I would recommend that Jack go for the S Corp.

Just for fun, what if Jack were offered a pirate job as a wage earning position? All W2 income with no self-employment at $100,000 per year? Just running the numbers straight like that, his 1040 taxes would be $18,341 and his FICA withholding would be $7,650 so his total tax cost would be $25,991 which turns out to be $1871 more than his S Corp taxes.

Now in real life, there would be other considerations – like health insurance and other fringe benefits that might make Jack want to jump at that wage position. But I left all of that out for this comparison.

The chart at the bottom of the post shows the numbers for Jack’s case side by side so you can see how I got to my numbers, in case you want to replicate them for yourself.

So, how do you determine if YOU should have an S Corporation instead of a sole proprietorship? You look at these numbers and it’s pretty persuasive. If you could save $6,000 or more a year, who wouldn’t do that? But taxes have a lot of moving parts these days. Maybe you have investment income, maybe you have wages from another job. Maybe you have deductions that are allowed on a Schedule C that aren’t allowed for an S Corp. Healthcare costs can also make a difference and so can your retirement savings goals.

If you don’t run the numbers fully through a tax program, including the payroll tax costs, you could actually lose money going with an S Corp. I ran a scenario the other day – this is a real person’s actual numbers: her tax savings by converting to an S Corp–before adding in any payroll taxes, was only $1,338. She’d spend that much in accounting fees for the payroll and additional tax return. Adding in the FICA and employer payroll taxes we send her to the loss column. I never would have known that had I not sat down and ran the numbers based on her whole situation.

While that taxpayer’s situation was unique, your situation is also unique to you. Before electing to be an S Corporation, make sure you have all the facts and run all the numbers. You’ll be glad you did.

Here’s that chart I promised you:

Comparison of wage, vs. self-employment, vs. Sub S Corporation taxes

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.

Posted on May 15, 2012January 14, 2017 by Jan Roberg

Small Business: Proving You Have Income Without a 1099-MISC

Good records will prove your income to the IRS.

For some small businesses a simple wire bound receipt book is all you need to substantiate your income.

Now some people may be wondering, “Why would I want to prove I have more income than I have to?” But for many small business owners, that’s exactly the problem—you have income, you want to report it to the IRS, and you’re having a hard time proving it. This post is for you.

The number two reason for reporting your non-1099 income (number one of course being basic honesty) is qualifying for the Earned Income Tax Credit. 2011 sort of hit small business owners who normally qualify for EIC with a one-two punch. We had the new 1099 reporting requirements that upped the ante for so many businesses, and we had the new EIC tax preparer due diligence rules with one of the questions being “Do you have forms 1099-MISC to support the income?” With the next question being, “If not, is it reasonable that the business type would not receive Form 1099-MISC?” Here’s a clue: if you answered NO to the first one, you have to answer YES to the second.

So what types of businesses wouldn’t normally receive a 1099? Bunches of them! Face it, if you’re reading this—I’m guessing that your business doesn’t receive 1099s. Generally, it’s reasonable to expect that anybody who works for other people, as opposed to other businesses, would not receive a 1099. House cleaners, dog walkers, handymen, lawn mowing services, daycare providers, interior decorators, and even income tax preparers are all types of business that could easily never see a 1099. (Yeah, me too! Although I’m now getting 1099k forms because I take credit cards, I don’t get 1099-MISC for preparing personal tax returns. Maybe I’ll see some 1099-MISC forms from some of my business clients this year, but I never used to get them in the past.)

So, how does a small time personal service provider prove his or her income to the IRS? There are a couple of things you can do. I’m going to start with my favorite: the business bank account. This is what I do and several of my clients do it too. (Okay, because I’m their accountant and this is what I tell them to do.) Get an Employer Identification Number (EIN) for your business and set up a separate bank account for your business in your business name. Only business income goes in, only business expenses go out. You may have to put some of your own money in for a start up, and once you’re making money you’ll take out a draw, but you’ll label those as such. Other than those two items, your business checking account is pretty much your profit and loss statement as well. Now for a bigger company that would be over simplifying things, but for us little folks–I’m spot on. See this post for more information about getting an EIN number: Free EIN

Why does this make good proof? Because you’ve got a monthly record of your income and expenses. I also have deposit slips to back it up: Mary Jones paid me $200, Fred Smith paid $250. It’s a good solid audit trail. Here’s another post about bookkeeping and your business bank account: Banking and Bookkeeping

But what if you don’t have a separate account? Maybe your business is just too small to bother with the expense of an extra account. What if you’ve just got something really simple like watching the little neighbor kid for a couple of hours after school every day. There’s no contract, no business cards, no advertising. You get $100 a week from your neighbor friend. She pays you in cash—it never sees the inside of a bank because that’s your grocery money. It’s not much but it supplements your child support. How do you prove that kind of income?

The easiest way to prove your income if you provided child care is to have the person you provided it for claim your services on their tax return. You make them a daycare receipt, just like the ones regular day cares do showing the name of the child, how much they paid you and your EIN number. (You can use your social security number but I never recommend that. You can get an EIN number for free. Protect yourself.) This is doubly good because the IRS will get confirmation of your income from an outside source. You prove income, your customer gets a tax deduction, it’s a win/win situation.

But what if your business isn’t day care? What if you did something like mow lawns around the neighborhood and shoveled snow in the winter? Nobody’s going to be claiming you on their tax return, what can you do? In your case, I like receipt books. You can find different kinds at Office Max or any office supply store. I like the ones with a carbon copy—one for you, one for your customer.

Now if you have just one customer and you’re always going to the same place—you can just use the little one that just has a couple of lines and the amount on it. You might write, “Mowing, Mr. Jones, $30, 5/15/2012” on it. You know what you did, who you did it for, how much you got paid, and when. If you have multiple customers you’ll want the larger receipt books that include the address and phone number of the customer. If you do different types of jobs for different people, you might need the bigger ones so you can write down the type of work that you did for them as well.

You don’t have to have a 1099-MISC to prove your income to the IRS. You just need to have a system in place to document your income and you’ll be fine.

Posted on September 6, 2011May 31, 2016 by Jan Roberg

Estimated Taxes for Small Businesses

Photo by Shayne Kaye on Flickr.com

I’ve gotten this question twice in the past week so I thought I’d post it on my blog:

I pay my estimated taxes out of my personal account, but really I’m paying estimated taxes for my small business, shouldn’t I take the money out of my business account?

That’s a really good question, and the answer is “It depends.” If you own a C corporation, then the answer is yes. But most of the small businesses I deal with are Sole Proprietors and Sub S Corporations; if you have one of those, the answer is NO!

Here’s why Sole Proprietors and Sub S Corporation Owners should not pay their estimated taxes out of their business accounts: All of the profits from these kinds of companies are taxable to the individual that owns them. The companies themselves pay no tax, the individual owner does. Because the owner, not the company, owes the tax, the owner must pay from his personal account.

Let’s do an example: Daisy Duke owns Daisy’s Delightful Doggie Daycare (D4). It’s basically a pet-sitting business she runs out of her home. Daisy’s pretty savvy about accounting, so she maintains a separate bank account for her business and she claims every legal deduction she’s entitled to. She runs all of her business expenses through her business account.

For the quarter, Daisy has $10,000 of income and $6,000 of business expenses. She wants to make an estimated payment on the remaining $4,000 of income. Daisy determined that she spends 40% of her net income on federal taxes so she’s going to send $1600 to the IRS. This check is not written on the D4 checking account, but instead on Daisy’s personal account.

Note that Daisy runs all of the business expenses through the business account, but because the taxes are not considered to be a business expense, they can’t go in there. If Daisy were to take her kids to Chuck E. Cheese’s for pizza, she would not pay for that out of her D4 account either. Now it’s sounds crazy equating estimated tax payments with Chuck E. Cheese’s Pizza but to the IRS’s eyes, they’re the same thing—a personal expense.

So here’s the next question that people always ask: What if Daisy doesn’t have enough money in her personal checking account to pay the taxes? That’s another good question. Remember, though, that the reason Daisy has to pay estimated taxes is because she’s making a profit. She’s got that $4,000 of profit sitting in her business bank account. She can make a payment to herself because she owns the company. She’s paying herself a draw (or maybe with an S Corp a salary), but when you own the business and you have a separate business account, you are allowed to pay yourself from the account.

Next question: But isn’t it a waste of time? Aren’t you writing two checks-one to Daisy and then one to the IRS, when writing one check directly to the IRS would solve the problem? No, it’s not a waste of time because it’s worth the extra five minutes to keep your books straight.

If you keep your business books strictly for business, with no personal expenses running through there at all, the IRS is going to think you’re pretty boring and not worth wasting much time on trying to audit you. This is one of those times where boring is good! Remember, paying your estimated taxes out of your business account is seen to be the same as taking your kids to Chuck E. Cheese’s Pizza. It’s a cheesy expense! (Sorry, that pun flew out of the keyboard, I couldn’t stop it.)

Many small business owners get into tax trouble because they wind up using their business accounts for personal spending. While your estimated tax payment seems like it would be a business expense, it’s not and you have to keep it separate.

Posted on August 2, 2011May 31, 2016 by Jan Roberg

Five Things You Can Do to Reduce Your Self-Employment Taxes

Author’s note: Yes, this is a stock photo that I bought online. My home office has never been this neat and tidy. But that green accountant’s lamp? I’ve got that on my desk too!

A fellow business owner told me that he was really surprised last year at tax time. His business had done well and he didn’t have many expenses to offset his income. You want to have income—it’s sort of necessary if you like to do things like eat, wear clothes, and have a roof over your head, but the more income you have, the more you pay in taxes. These tips are things that you might be spending money on anyway that can help reduce your “business income” and reduce your self-employment tax.

Claim a home office. If you are working for yourself, you should have a home office. I actually have two offices: one in an office building where I meet clients, and my home office where I perform administrative duties like paying my company’s bills. If you have more than one office, your home office should be your administrative office—doing so makes your commute to the other office a deductible expense (normally, commuting is not deductible).

If you’re already claiming a home office, make sure that you’re maximizing your deduction. Did you know that hallways, stairways, crawl spaces, and bathrooms don’t count towards your total square footage? And don’t forget to claim the depreciation on your home. I’m always amazed at the number of folks who don’t claim it. If your business has a loss, the deduction carries forward to next year.

Hire your kids. If you have children under the age of 18, you can pay them to work for you and you aren’t required to pay FICA, and you don’t have to pay Federal Unemployment tax on them either. The work has to be real and the wages have to be commensurate to what you’d pay someone who is not your child. They also have to do work for the company, not things like clean up the kitchen for this to count. Have them keep a time sheet so that you have documentation of the work in case the IRS checks on it. For this you must be a sole proprietor, you can’t be a Sub S corporation.

Hire your spouse and set up a Section 105 Health Plan. Sure you can deduct your health insurance on the front of your tax return, but it doesn’t affect what you pay in self-employment taxes and it only covers your health insurance. With a Section 105 Health Plan, you hire your spouse as an employee and the compensation package includes 100% health coverage for him (or her) and his family (which includes you). This has the effect of putting all of your family’s health care expenses as a deductible business expense. Just like with hiring your kids, your spouse will have to perform a real job for the company, keeping a time sheet, etc. (You must be a sole proprietor, LLC is okay. You cannot be Sub S Corporation.)

Maximize your auto deduction. The majority of people claim auto mileage for their business because it’s easier (I’m talking about claiming real mileage and not the folks who go around claiming 40,000 business miles a year on a car that’s only been driven 12,000. I like to stick with honest deductions). For a lot of folks, it’s worth it to claim your actual expenses, especially now with the price of gas so high. Take the time to really keep track of your actual auto expenses for one year. This will vary a lot depending upon your auto usage, but for some people it’s a big savings. Compare your actual expenses to the standard mileage rate and claim whatever gives you the larger deduction. Remember, you still have to keep track of your business versus personal miles to claim your actual expenses as a deduction.

Posted on March 2, 2011May 31, 2016 by Jan Roberg

Why You Might Want to Let Your Spouse Own Your Business

Photo by Living in Monrovia at Flickr.com

First and foremost—this post will only apply to a limited number of people, so please don’t go changing your business ownership based on the title.

One of the downsides of owning your own business is that you have to pay self employment tax. Self employment tax is 15.3% of your profit, you pay it in addition to your regular tax rate. So, if you’re in the 25% income tax bracket, you’re actually paying 40.3% in taxes on your self employment income. That’s a lot of tax.

Social security makes up 12.4% of that. (8.4% for 2011 only.) The maximum amount of your earnings that are subject to Social Security taxes is $106,800. Once you cross that threshold, you don’t pay Social Security tax anymore for the year. If you’re in that situation, you know how great it is when your company quits withholding your Social Security, it’s like a temporary pay raise.

So let’s say that you own a small business with a net profit of $50,000. Your husband gross pay is $125,000 a year. He’s already completely paid up for his Social Security. After claiming all of your deductions, let’s say your taxable income is $135,000 – that’s still in the 25% tax bracket. Your tax liability would be $33,765. That would be $26,115 for your regular tax plus another $7,650 for your self employment tax.

But what if your husband owned the business instead of you? He’s already maxed out his social security taxes. In this case, your total tax liability would be $27,565. That would be the same $26,115 for the regular tax, plus only $1450 for the self employment tax (it would be the Medicare portion.) In this example, it’s a total tax savings of over $6,000.

What are the downsides? Obviously, you wouldn’t want to have your business in your spouse’s name if divorce were a possibility. It wouldn’t make sense to do this if your spouse’s wage income wasn’t above or at least near the social security maximum threshold. Also, by putting the business in your spouse’s name, then you’re not contributing to your social security pool for the future. See that $6,000 saved in the scenario above? The best thing to do with that money is to put it towards your retirement.

Another issue is continuity. If you’ve had your business in your name for 20 years, why would you change it now? On the other hand, if you’re starting a new venture maybe it makes sense to set it up that way. You may have other perfectly legitimate reasons for not doing this as well. It’s an option for saving some money, certainly not a requirement.