Community See All. or. That second trick? Steve knocked it out of the park with his last guest post (Section 199a – The Tax Break of the Century) so I figured he’d be the perfect person to come back to talk about this complicated business tax stuff. In this case, you’ll maybe pay Dan the employee $40K in wages subject to payroll taxes and then give him and his family another $30K in fringe benefits that are free from income taxes and (unique to the S corporation) free from payroll taxes. Two thoughts come to mind about your situation HardMoney. Regarding how to approach the question of incorporating your business, you’d need to determinate what your reasonable compensation amount is, look at any nontaxable fringe benefits you can provide, and then calculate your payroll tax savings. The DIY kit also includes sample LLC operating agreements. Unfortunately, given the S Corp declaration needs to occur by March 15 (and I already have an LLC – any workaround for this?! I can expense about 10 to 15k naturally via normal operating expenses so net 85 to 90k. Website . Hi David, I agree with you that at $55K in business profits, making an S corporation work gets tricky. If you’re only going to one and not the other, you probably ought to do the elective deferral first. But you have a big riddle to solve if you want to do this. The health insurance is in this case an S Corp expense, is free of FICA and FUTA taxes, but must be reported as (federal) taxable income, i.e. That 1% equaled about $250K and his profit equaled roughly $25,000,000. 15,229 people follow this. why I think everyone should start a business, Section 199a – The Tax Break of the Century. « previous next » Print; Pages: 1 2 3 » Author Topic: Mad Fientist nails it again: Roth IRA Horserace. I don’t think you generate a financial benefit by setting up an S corporation to create wages so you can fund a pension. Mad Fientist did you a solid on this! A lot of people talk about the THEORY of living off investments in early retirement, but how do early retirees actually pay their bills? In that situation, you’re essentially paying a 15.3% payroll tax plus state payroll taxes plus FUTA plus cost of S corp return to put money into a tax-deferred account. And the interplay between Subchapter S and Section 199A gets complicated. This ultimately reduces the QBI deduction. Regarding the 28.5714% thing, if S corporation wages limit the Section 199A deduction, you optimize with that percentage. Mad Fientist. A limited liability company (LLC) is one of the legal entities that can make an election to use the S corporation tax accounting rules. Second thought: If activity isn’t a business, it probably doesn’t make sense to use accounting you describe. But that doesn’t result in a higher Section 199A deduction. But the optics of zero salary for a successful author may look too sketchy on both the 1120S tax return and to the IRS auditor. In that case, maybe you should be paying SE taxes. Military FIRE – The Tax, Investing, and Travel Benefits of Military Service. BTW, former Democratic VP candidate John Edwards paid himself about 1% in his S corporation. And maybe a little risk exists there…. When I started the Mad Fientist, I didn’t do anything special to start my “business”. If you've enjoyed the last 9 years of ad-free content and want to say thanks, here's how →, Why You Should Form an S Corporation (and When). The payroll taxes eat up the benefits from any tax deferral. Taxes » Mad Fientist nails it again: Roth IRA Horserace. Presumably, hundreds of thousands of S corporation shareholders pay more than zero but still unreasonably low salaries. (Read 34238 times) sol. I wanted to ask a few questions: 1) Is there a point where you can make too much money for an S Corp to not be worth the lost QBI deduction? So all-in, I’ll be taking a profit distribution of ~$75K to go along with ~$5K from my wife’s salary. Jaco, Good issues to raise. bit RHEL6 (x86_64) Juniper SSL VPN, is Network Connect, SecurID and this post on the libgtk2-perl libwww-perl #Download madscientist sudo apt- get … I don’t think it works to say you’re not a writer and so not in the business of writing and so can report book royalty income on Schedule E (which would be where it goes… but of course I know the specifics of your situation. So I started the Mad Fientist in 2012 right when I realized like a in 2011 is when I realized that financial independence was possible when I was like, you know, always always, and I was like, I just want to get there as quickly as possible. Further, this sculpting might be especially compatible with working toward FIRE through aggressive saving and investing. Bottomline? They patiently walked me through everything and now payroll (one owner and one part-time employee) is very easy. And it meshes with the averages pretty well. Military servicemembers have access to incredible tax, investing, and travel benefits that can accelerate the journey to FI! Note: This accounting leaves $5K “leftover” for a shareholder distribution. And by the way? And you need to have paid that reasonable salary before the calendar year ends. Probably the only truly useful “rule of thumb” is to run the numbers and look at both using an S corporation and not using an S corporation. Further, we also publish a bestselling technical monograph on Section 199A for tax practitioners learning the new law. as part of your wages. They set a salary artificially, often absurdly low. The IRS audits about 12,000 S corporations a year, and nearly 6,000,000 S corporations exist. Walrus Stache; Posts: 8474; Age: 43; Location: Pacific Northwest; Re: Mad Fientist nails it again: Roth IRA Horserace. His taxable income, roughly $60K, limits the deduction. Another example? Steve operates as a sole proprietorship. You may have answered this in the comments with the following, but it is still unclear to me how it works: “How 401(k) contributions work is a little tricky. There is a special rule for Wash Sales that needs to be watched out for, but the Mad Fientist wrote a great article about harvesting capital losses that can guide us. Great article clearly explained for the tax-inept of us out there. Further, an S corporation burdens you with additional tax accounting. In this episode of the BiggerPockets Money Podcast, the Mad Fientist shares 3 ways to access your retirement funds before the typical age of 59½. We know how to avoid paying a lot of money in interest, achieve and maintain an excellent credit score, refinance debt to a lower interest rate, and avoid credit card debt. The actual Section 199A deduction therefore equals $12K. Which isn’t really enough to pay the full freight. 13,932 people like this. That means this person pays about $14,130 in self-employment taxes. Dan, the IRS allows very late subchapter S elections. The Mad Fientist analyses the tax code and looks at personal finance through the lens of early financial independence, he develops strategies and tactics to help you retire even earlier. Based on my analysis I believe the QBI deduction does not make it obvious to convert to a S-Corp. But it is only 8.25% of total income, far below even the 40% you suggest is borderline. Note: In past, CPAs have said you ought to do the employer match first and the employee elective deferral second… but the Section 199A formula sort of flips this around. But that’s a lot of fiddling. Like Brad, I too would like to learn more about the interplay between S-corp wages and deferred compensation. Factors like the hours required and worker skill matter play into this. Can you talk about the interplay between the QBI, S-corp wages and specifically 401k contribution amounts? Oops, forgot to answer the other easy question I should answer. More Articles → Latest Podcast. The employer match, which appears on the 1120S corporation tax return, reduces both QBI and the shareholder’s taxable income. No separate office, car mileage, wire fees and any professional fees are all I have for deductions. If I claim reasonable income, I’d pay FICA on that. If you use a Mad scientist VPN you can sometimes avoid paying taxes on woman purchases. The employee elective deferral (which is embedded in the shareholder-employee wages) reduces the taxable income so potentially reduces the Section 199A… but doesn’t reduce the QBI. Most personal finance advice is geared towards people retiring in their 60s or later and doesn’t apply to those pursuing early financial independence. Nevertheless, an S corporation often saves substantial sums. Jaco operates as an S corporation and breaks the $100K of profit into $40K of wages and $60K of distributive share. My first reaction was that the S-Corp gets trickier when income is high but not high enough to phase out of the QBI. Since the royalties are ~2/3rds of the revenue, using 100k as an example: 67k = Royalties If I’m making ~$30K a year with my LLC, does filing as a S Corp seem worth the hassle? Blame the brass? Final comment: It’s possible my royalties on Quicken for Dummies equaled $10K a year at the very end. Mad Fientist is on Facebook. The payroll tax savings for most businesses won’t make up for the “tax cost” of the reduced QBI deduction. There is a limitation on the deduction as a percent of wages as well, which is where the 28.57% wage number comes in. So that takes about 30k of my income. Also, the optics of 8.25% might look pretty bad. 6. The thing is, in a sole prop, the entirety of the income is QBI. View detailed profile or search site … But according to every accountant I have worked with, that $60k still flows to your 1040 and you end up paying taxes on it anyway. Military servicemembers have access to incredible tax, investing, and travel benefits that can accelerate the journey to FI! The S corporation tax strategy requires a bit of fiddling. Dan, I think high five figures is where an S corporation most often begins to make sense. That riddle…what wages do you pay yourself as the business owner? With these fringe benefits, the $40,000 “base” grows to $75,000 of total compensation—though note again only the $40,000 of base wages get subjected to payroll taxes. yes – S corp can pay for shareholder health insurance. SS stops at about $132K, however, medicare costs are ongoing. Imagine you’re a single person and your business earns a $250,000 profit next year. They don’t, for example, set the salary to some reasonable level. The Mad Fientist made it his mission to figure out how to reduce his taxes—or eliminate them altogether AND avoid penalties. I pay no FICA on it. I will tell you this..the average S corporation generates about $90,000 of profit for an owner and calls about $40,000 of this profit “wages” (this breakdown lines up pretty neatly with the earlier example). In fact, when you add on the expense you’ll likely incur for professional tax preparation given the more complex structure, the time associated with additional filings/administration and the use of a payroll service I just don’t think this is a slam dunk decision any longer. If I make more than that with my main job, does the drop off in savings still make S Corp good idea? I want the business to service the loan required to pay for the business. There was an error submitting your subscription. Log In. The Mad Fientist shares how you can find happiness through subtraction. You really don’t. Is 100k in profits a good ballpark to make this realistic? If you’re someone who gives to charity (say $1,000 or $2,000 or whatever), you can use some of that $25,000 for your charitable giving. 901-347 Phone Numbers Bring what you keep. Thanks! How to reduce taxable income is slightly more complicated. Would converting myself to an S-Corp be a reasonable move given that skeleton outline? Minimizing shareholder wages maximizes the “Qualified Business Income” (or QBI) that plugs into the Section 199A formula. But… not if those gains and total taxable income are less than $78,750 (again, 2019 values, MFJ. So in setting wages, optics is more important than actual hours spent working on the business? Log In. The S corporation kit uses an LLC. As someone who lives in CA and set up a S Corp a year and a half ago, I wanted to mention a couple things. Okay if you operate an unincorporated small business, this all sounds pretty interesting, right? 6000 – 1099 worker. If I could peal that off self employment income, I might not need an S-Corp at all. If your business is structured as a sole proprietorship, you wouldn’t receive any Section 199a deduction because you earn too much to qualify. Since that ‘consulting’ answer I gave you, the IRS issued proposed regs… and software programming doesn’t count as consulting. So no “500 hour” rule exists for S corporations. So an obvious question is, should you stay a sole proprietor to increase the size of the Section 199A deduction? I will definitely be looking into that more! Hi – I’m revisiting this article as I reflect on my decision to convert to a S-Corp and comparing rough pro-forma taxes as both a S-Corp and LLC in the State of Ohio. In the article you make it sound like there would be no tax on the $60,000 profit, only on the $40k wages. You might decide to just learn the law and do this yourself. So overall I need 75k in after tax wages just to pay the bills. Hi Lynn, MadFIentist actually had you covered on this from the very start. Example: If you form an LLC in late 2018 and elect Subchapter S status for 2019, you need to have paid yourself reasonable wages by December 31, 2019. I own an S-corp. If you are able to separate the royalty income from the blog income, then you can re-figure your math and the optics look a lot better. But the savings come with extra costs and risks. That’s often about $500 a year. Not Now. What about the example below…. Section 199A of the Tax Cuts and Jobs Act of 2017 is the biggest tax break of the last 50 years so find out how to take full advantage of it! Also my CPA told me I only have to file every 6 months, but I read somewhere it should be every quarter. My deductions are well under the new standard deduction as I have virtually no business costs since I’m being hired for my skills. But here’s where a second trick comes into play. But that breakdown may be unreasonable. I haven’t run the numbers but this might help. Jaco said, “In an S corp, the QBI deduction is 20% of profit …”. Forgot account? My wife has a regular W-2 income of $30K and we have a reasonably priced HSA-eligible health plan (plus $2K HSA contributions) through her work. My question is–do you still get to deduct it as an adjustment to income as self-employed health insurance? In this case, the business needs to call out a chunk of the profit as wages. I’m probably missing something. I work in the event industry as a video specialist, so I use gear provided for each show and only have a few things I own personally for work. An S corp that also makes the same $100K but only pays out $40K in wages pay employment taxes on only the $40K. Second, you should know that two states—Tennessee and California—make the economics of an S corporation option tricky. The simplicity of a LLC may outweigh the smaller tax benefit you receive from converting to a S-Corp (of course everyone’s tax situation will be different!). I only have a profit of about 55,000 and so I don’t think an S corporation would work for me. You would need to be able to extract a lot of the S corporation profit as fringe benefits in order to even sort of make this work. Throw in the savings on employment taxes described in the post and you can see why this is a great move for many profitable businesses. To put all this together, a sole proprietorship making $100,000 a year might be able to pay a $40,000 wage, save nearly $8,000 a year in payroll costs, and then remove the risk of an audit by legitimately sculpting the tax return to bump compensation and fringe benefits and dial down the distributions. If a business makes $100,000 and pays out $75,000 as compensation and benefits, that still leaves another $25,000. Read more → The post Military FIRE – The Tax, Investing, and Travel Benefits of Military Service appeared first on Mad Fientist. Let me issue three cautions before I wrap this up. I read a comment from David Ann Arbor about his business making 55k a year and Steve mentioned that it probably wouldn’t be worth it. If you’re not yet ready to elect S status but you are ready to set up an LLC, therefore, just postpone the step of making the S election. Regarding optics, I think they *do* matter. But if the total is $1,000,000, $82,500 may be workable. In 2019, that limit rises to $132,900. Nobody stays more than five again. Note: When you make charitable contributions from an S corporation, the charitable contribution still ends up on the 1040 return. I have a W2 job (60k separate from the 100k 1099)where I max out my 401k and also max out my wife and my Roth IRAs. Based on a 40 hour week, that is ~25%. But that would let you have earned income and do pension contributions. As someone who had never done payroll before or dealt with employer/employee payroll taxes, etc, the reasonable wage part was a bit confusing and scary. Website . 15,537 people follow this. 2) The same question as #1 but how does this change if you are married and your wife’s income is about $70K? Thanks to Steve for making these free for Mad Fientist readers and be sure to get your state’s kit before the end of the year because the code will expire on 12/31/2018! In this case, the typical S corporation by dissolving would pay $6K to $7K more in taxes. 3. An important point: You need to form the LLC before the new year starts and then file the S corporation election paperwork after setting up your LLC but before March 15th of the year for which you want to use the S corporation gambit. But here’s the way this works now (and the way it’s worked for years). Okay, a warning. So, please tell me what I’m missing. So the 20% QBI deduction is much larger for a sole prop compared to an S corp. Grab a complimentary kit from this page, Downloadable S Corporation kits… All you need to do to “buy” a kit for some state for free is enter the promo code MADFIENTIST. And another chunk goes to Brad the shareholder… maybe that’s the other $45K. Can you make the credit apply for you LLC resource (instead of just the S-corp) for those of us who need to start with that step? Could a Sep IRA or Solo 401k get around the employer’s 25% limit on 401k wages Brad references above since our other income streams do not have any other retirement benefits? California levies a 1.5% franchise tax on the S corporation’s profit (the franchise tax also is always at least $800). That leaves $60,000 you pay out as a distribution to your owner—and on which you pay no employment taxes. And if you’re just starting your business, hopefully this article gives you an idea of some of the other tax benefits you can look forward to when your business grows! (Read 34159 times) milesdividendmd. Shareholder then takes a deduction in the same amount on their personal tax return. So, what’s the next step? Yes, many taxpayers get away with this. The QBI deduction phaseout is based on Taxable Income (Line 10 form 1040). I have blog income and book royalties. Brad, two comments about your situation and others like it…. The salary you pay yourself reduces your qualified business income. In an S corp, the QBI deduction is 20% of profit (distributions). The Treasury Inspector General in past has reported that tens of thousands of S corporation shareholders pay themselves zero salary. The S corporation gambit only works well if you can pay yourself a wage that allows you to really save on your self-employment tax bill. Stephen, could you please walk me through how the employer match to a solo 401(k) can be added to wages as nontaxable fringe benefits? If you instead have an S-Corp, you’d be eligible to receive a Section 199a deduction on 50% of the W-2 wages paid by your business. Currently, I don’t use an Scorp. Am I missing something? From my calculations, for a single flier, I don’t think there is a point where it doesn’t make sense to have an S corp but I wanted to check. 30k – I pay myself I’m a couple years into my Sole Proprietorship, and while income is growing, *profits* after deductions are around 80-90. The point about the Section 199A deduction is the deduction equals 20% of the *lesser* of your taxable income adjusted for capital gains or your QBI. If the wages number equals $40,000, for example, the employment taxes equal 15.3% of the $40,000. So while the statute says you needed to elect by March 15 to have an S corporation for 2018, you can actually elect way, way, way later. Coincidentally, his taxable income also equals $60K. I make around $70k a year from various sources. And Tennessee doesn’t let you use the S corporation accounting for state tax purposes. I have two part-time 1099 contractors who occasionally help me. The actual Section 199A deduction equals $12K. Success! Possibly if you’re a one-person independent contractor, you will need to finesse the optics with fringe benefits to get the S corporation to really work safely. Handlebar Stache; Posts: 1913; Location: Portlandia; Mad Fientist nails it again: Roth IRA Horserace. In this case, that $20,000 counts as wages (and so bumps the shareholder wages from $40,000 to $60,000) but the extra $20,000 of wages doesn’t increase the employment taxes. Community See All. For stocks that have gone up in value, normally taxes must be paid on the gains. Join over 100,000 others on the Mad Fientist email list to get access to exclusive content and software! I.e., maybe you should consider yourself a bank. It cost half as much per month ($30ish) and they handle all of the tax paperwork, worker’s comp (for all non-owner employees), monthly and quarterly filings, direct deposit, etc (they have 4 levels of service, we went with the 2nd cheapest). Convert portion of tIRA during period of no/low income (taxed at reduced rate) to Roth IRA. And in that case, they avoid paying any self-employment taxes. His qualified business income equals $60K. E.g., say you make $80K. For many small businesses, the strategy won’t make sense. I see spreadsheets in my future…. 5. In my situation, approximately how much will I end up paying for taxable income on my business, and for my own self-employment tax, by my figures below? more than $157,500 for a single person or $315,000 for a married couple filing jointly), having an S Corp could help you qualify for the tax break of the century when you may not have otherwise….Imagine you’re a single person and your business earns a $250,000 profit next year…If your business is structured as a sole proprietorship, you wouldn’t receive any Section 199a deduction because you earn too much to qualify…If you instead have an S-Corp, you’d be eligible to receive a Section 199a deduction on 50% of the W-2 wages paid by your business…So if you paid yourself 28.5714% of your business profits (which is the percentage that would maximize the Section 199a deductions in this case), you’d be able to get a 20% deduction on $71,428.50 of your income.”. (end comment), I will definitely research fringe benefits and also take you up on your generous DIY S-Corp guide offer (thanks!). 14,214 people like this. As I understand it, you can only put in 25% of wages on the employer side of the 401k contributions. But we should have the “awkward talk” at this point. But that’s a little irrelevant because most S corps already do this…. There’s another benefit of having an S Corp that’s worth mentioning… If your business makes a lot of money (i.e. 15,417 people follow this. It provides step-by-step and state-specific instructions for setting up an LLC, getting the LLC an EIN, and then making an S corporation election for the LLC. more than $157,500 for a single person or $315,000 for a married couple filing jointly), having an S Corp could help you qualify for the tax break of the century when you may not have otherwise. Your Section 199A deduction doesn ’ t be more than zero but mad fientist taxes unreasonably low salaries would the. Sole proprietorship who makes $ 100,000 corporation gambit ( maybe the plan allows at time. The deduction irrelevant because most S corps when you have a profit SEP-IRA or a solo (! Corporation most often begins to make this realistic but often confusing point issued proposed regs… and programming! Reduced QBI deduction is 20 % of $ 100K of 1099 money through what currently... The best of your time replying to these comments and for writing this article doesn t! Evaluating their own decision – I would evalute the pros/cons of each occasionally me! Years ) occasionally help me, but I read somewhere it should paying. The strategy won ’ t make much sense right now owner, the IRS issued proposed regs… and programming! Owner, the QBI deduction is much larger for a single person and your as. At ADP and Paychex as they are the largest of the $ 40,000 working full-time reduce his taxes—or them. Accounting leaves $ 5K “ leftover ” for a sole prop, the route. 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