His writing on tax, spending, and life optimization guided me on my own FI journey and I’m grateful to now call him a friend. You said S Corps are not good for side hustles, but I thought if you work less than 500 hours a year on your S Corp business then you can classify the entirety of the income as profits, not have to call any of it wages, and then pay 0% self-employment tax. If I’m making ~$30K a year with my LLC, does filing as a S Corp seem worth the hassle? why I think everyone should start a business, Section 199a – The Tax Break of the Century. Success! Website . I own an S-corp. (This point gets missed by most people who wonder about dissolving an S corporation.) How 401(k) contributions work is a little tricky. Mad Fientist Note: I used one of these kits to set up my Florida LLC and S Corp and it made the whole process super simple. The work on the book having been done years ago, the royalties are completely passive. Now just check your email to confirm! 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. Mad Fientist. The 25% employer match applies to the $60,000 of wages, which means another $15,000 of nontaxable fringe benefits. The biggest problem, however, is the 5-year waiting period, so you have to have a decent amount of post-tax money already available in order to optimally execute on this strategy. While you will still enjoy the benefit of the reduction in FICA tax, the offset of the reduced QBI deduction makes the difference much less impactful. 15,417 people follow this. My question is about the S Corp paying the health insurance for the single employee (and their family). Yes, many taxpayers get away with this. as part of your wages. The one other rule to consider: Once you operate your business as an S corporation, you must pay yourself a reasonable salary. If you’re a sole proprietor, you pay the 15.3% self-employment on 92.35% of this $100K (as MadFIentist graphically shows earlier). Over a year-and-a-half and two million plus downloads later, the Afford Anything podcast has hit another awesome milestone: the 100th episode! Episode 525: Happiness Through Subtraction by The Mad Fientist (Minimalist Finances & Financial Freedom). The thing is, in a sole prop, the entirety of the income is QBI. Factors like the hours required and worker skill matter play into this. It would not surprise me if you can save substantial amounts with an S corporation. If you use a Mad scientist VPN you can sometimes avoid paying taxes on woman purchases. I’ll contribute the full $55K to my solo 401(k) along with about $4K to an HSA. But because you’ve raised the subject, let me point out a handful of things: First, some people need an S corporation in place to get the Section 199A deduction because they need W-2 wages in order to get the Section 199A to work. In this case, the typical S corporation by dissolving would pay $6K to $7K more in taxes. – latest numbers here.) (I received royalties for “Quicken for Dummies” for two decades… and I continue to receive royalties for “QuickBooks for Dummies” even after two decades.) The Mad Fientist analyzes the tax code and looks at personal finance through the lens of early financial independence to develop strategies and tactics to help you retire even earlier. In your opinion, is that still borderline in terms of work-ability with this approach? or. To ignore the effect of the potentially significant reduction of the QBI deduction when moving from a sole prop to an S corp is to miss the forest for the trees. I can expense about 10 to 15k naturally via normal operating expenses so net 85 to 90k. No separate office, car mileage, wire fees and any professional fees are all I have for deductions. (end comment), I will definitely research fringe benefits and also take you up on your generous DIY S-Corp guide offer (thanks!). Two thoughts come to mind about your situation HardMoney. (Read 34159 times) milesdividendmd. Most personal finance advice is geared towards people retiring in their 60s or later and doesn’t apply to those pursuing early financial independence. If your business makes a lot of money (i.e. I think Social Security maxes out around around $108K, right? To the best of your knowledge, am I correct on this, or am I missing something? Third, an S corporation’s reduced wages reduce your future Social Security benefits. If what a software consultant really does is programming or design, that’s probably not really per the Section 199A deductions a “consulting” activity. However, what you really ought to do in a situation like this? See more of Mad Fientist on Facebook. 1. Jaco operates as an S corporation and breaks the $100K of profit into $40K of wages and $60K of distributive share. 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. 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. 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. Bottomline? 15,537 people follow this. Am I missing something? I think most smart people are trying right now to figure out how to do the opposite of this article – to dissolve their S corps and get back to a sole prop, or form a partnership. The Mad Fientist, on your behalf, arranged for our offices to supply complimentary copies of our DIY S Corporation formation e-book. 33k = Blog x 25% = $8250 wages. Dan, I think high five figures is where an S corporation most often begins to make sense. Hi Lynn, MadFIentist actually had you covered on this from the very start. Community See All. In my analysis, the S-Corp still had the lower overall tax burden but it was not significant. (Read 34238 times) sol. Regularly S corporation owners go ape when setting their salaries. Both are married and take the new standard deduction, $24K. That is, non earned income. Withdraw Roth IRA conversion amount, which is treated as a Roth contribution. And then that money can’t be reclassified as wages. I haven’t run the numbers but this might help. My last article described why I think everyone should start a business and this post explains the benefits of forming an S Corp once your business becomes more profitable. 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. Or say the reverse… that you have $20K of pension and $10K of health insurance. But what if you form an S Corp or sole proprietorship, generate income, and create a friendly Solo 401(k) that allows you to convert? To assist me with this article, I brought back the tax mastermind who helped me switch my own business over to an S Corporation – my personal accountant, Steve Nelson! The bottomline: Your payroll tax savings in this case equal about $5300. The rule is, an S corporation must pay its shareholder-employee reasonable wages. Annually. Please try again. So, please tell me what I’m missing. Someone working part-time would logically earn less than someone working full-time. Mad Fientist did you a solid on this! Join over 100,000 others on the Mad Fientist email list and start tracking your progress in the FI Laboratory! Notice step 5. This benefit alone could save you thousands of dollars! But that doesn’t result in a higher Section 199A deduction. If I make more than that with my main job, does the drop off in savings still make S Corp good idea? First, making the S corporation thing work for a side-line or supplemental business is tougher. Thanks for the post, Steve! The Section 199A deduction equals the lesser of 20% of the qualified business income or 20% of the taxable income adjusted for capital gains. The S corporation kit uses an LLC. And then make that number even lower-risk by making the optics look good. Optics matter (in a sense) to the IRS computers trying to pick out the 12,000 S corporation tax returns the IRS will audit and to the hundreds of IRS auditors auditing those returns and trying to decide whether someone’s salary is reasonable. There is a limitation on the deduction as a percent of wages as well, which is where the 28.57% wage number comes in. 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. Let’s say Diana owns and works in an S corporation. The Treasury Inspector General in past has reported that tens of thousands of S corporation shareholders pay themselves zero salary. In either case, that extra accounting costs time or money or probably both (as a guess, maybe another grand for a small S corporation if you outsource the work?). If that is the case, where/how on the return would royalty income be reported? That means this person pays about $14,130 in self-employment taxes. Great article Steve! Further, an S corporation burdens you with additional tax accounting. Why would the sole proprietorship pay taxes on 100k if they can make further deductions? Minimizing shareholder wages also minimizes the FICA and Medicare taxes paid directly or indirectly by the shareholder. Episode 1076: Specific Identification of Shares by The Mad Fientist on How To Reduce Your Tax Burden on Taxable Investments Convert t401k to Roth 401k within a 401k plan during periods of low income. 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. Blame the brass? That would be the “real” number. Pretty cool! 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! If you set your salary too low, the IRS can reclassify distributions paid to shareholders as wages and then slap you with penalties. Advanced Strategies for Pursuing Financial Independence - http://www.madfientist.com I see spreadsheets in my future…. Regarding the 28.5714% thing, if S corporation wages limit the Section 199A deduction, you optimize with that percentage. The payroll taxes eat up the benefits from any tax deferral. Join over 100,000 others on the Mad Fientist email list and get instant access to my FI Spreadsheet! Jim, it’s possible that your book royalties wouldn’t be business income at all and therefore not subject to SE tax in the first place. Both save $16K into a pension. 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. If your business is structured as a sole proprietorship, you wouldn’t receive any Section 199a deduction because you earn too much to qualify. The employer match, which appears on the 1120S corporation tax return, reduces both QBI and the shareholder’s taxable income. There’s another benefit of having an S Corp that’s worth mentioning…. Example: You might form an LLC today—this very morning or afternoon, for example. BTW, former Democratic VP candidate John Edwards paid himself about 1% in his S corporation. Forgot account? My work is all in the same industry, but I work for multiple vendors/clients that pay a variety of 1099 or W2 depending on the payroll setup. Sure, some extra work but not that hard to deal with. The Mad Fientist made it his mission to figure out how to reduce his taxes—or eliminate them altogether AND avoid penalties. That 1% equaled about $250K and his profit equaled roughly $25,000,000. In an S corp, the QBI deduction is 20% of profit (distributions). Taxes » Mad Fientist nails it again: Roth IRA Horserace. Consider the two following small business owners: Both earn exactly $100K. I will definitely be looking into that more! View detailed profile or search site … But it is only 8.25% of total income, far below even the 40% you suggest is borderline. Coincidentally, his taxable income also equals $60K. yes – S corp can pay for shareholder health insurance. What are the benefits that prompted me to do it? Tip: Usually S corporations don’t work well for side hustles if you have another W-2 job. You said: “If your business makes a lot of money (i.e. You are correct that employer contributions are limited to 25% of employee compensation (wages). Regarding ‘reasonable salary’, if I determine $100K/yr is reasonable for my industry but I am only working 1/2 time, does that help my case to only claim $50K/yr as my salary? So in setting wages, optics is more important than actual hours spent working on the business? or. Mad Fientist (rent, taxes, rates, account) User Name: Remember Me: Password Please register to participate in our discussions with 2 million other members - it's free and quick! I know it violates the “optics” principle, however, I feel this could easily be justified to the IRS since the time spent in the business is so minimal. Now just check your email to get your spreadsheet download link! After expenses, at least initially, there will be little left over to compensate the two owners/employees (maybe $5k to 25k a year). Second thought: If activity isn’t a business, it probably doesn’t make sense to use accounting you describe. And what the shareholder saves is $3300-ish in FICA and Medicare taxes. This is a great post. And other than SEP-IRA/HSA, we don’t have any fringe benefits. So does it matter how you pay yourself after your “responsible wages” exceed 120k a year? Also my CPA told me I only have to file every 6 months, but I read somewhere it should be every quarter. On Diana’s 1040 tax return, she reports $50K as her wages subject to income taxes… but she probably also takes a $10K self-employed health insurance deduction. I’m probably missing something. This is because I believe that vanilla Roth 401k contributions are not subject to the five year rule, so long as they are rolled over to a Roth IRA that is five-years old. And by the way? NO Spam. Looking for free advice (how frugal of me) :). I.e., maybe you should consider yourself a bank. I have blog income and book royalties. Explaining that “toughness” requires 500-1000 words… but it boils down to way FICA savings work when you more than one W-2 job and the optics of the 1120S tax return which spotlight your S corp wages and your S corp distributions. 13,932 people like this. I make about 100k of 1099 money through what is currently my LLC. I was confused when trying to set it up and just called their help number. Thanks so much for the informative post. And in that case, they avoid paying any self-employment taxes. Not Now. Create New Account. She’s planning on contributing $19K of salary to her 401(k). However, suppose this person incorporates their sole proprietorship and makes an S election. Read more → The post Military FIRE – The Tax, Investing, and Travel Benefits of Military Service appeared first on Mad Fientist. 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. Your guidebook is the point. 6000 – 1099 worker. Add nontaxable fringe benefits like health insurance and employer pension contributions. Say she pays herself $40K in base wages and then also provides $10K of health insurance for her entire family. What about the example below…. Percentage of Profit Subject to Employment Taxes – S Corp. And this means the person pays about $6,120 in employment taxes. Dress up the optics of the tax return. 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. Not Now. Very informative! Military servicemembers have access to incredible tax, investing, and travel benefits that can accelerate the journey to FI! All of my borrowers report income to me on 1099-int. We did look at ADP and Paychex as they are the largest of the payroll outsourcing companies. In this case, your Section 199A deduction can’t be more than 50% of your W-2 wages. 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 claim reasonable income, I’d pay FICA on that. I am also in a situation dealing with the AMT this year for the first time so have had to look into strategies to avoid this. But that would let you have earned income and do pension contributions. 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. 2. Additionally, the QBI deduction does not fully phase out for a single flier until about $207K. I want the business to service the loan required to pay for the business. Hi Elton, the S corporation lets you avoid self-employment taxes (aka payroll taxes) on some of the pension fund contribution, your self-employed health insurance and on the amount of business profit not counted as wages. I’m currently a sole prop and the only employee. E.g., if your business generates (say) $120K of revenues or billings and you incur (say) $20K of business expenses, your business profit equals $100K. Final comment: It’s possible my royalties on Quicken for Dummies equaled $10K a year at the very end. Have a question, which might be another reason to form an s-corp/business: I was gaming out some stuff and ran into a couple of interesting scenarios based on the rules for Roth 401(k)s and Roth IRAs. Wait four to five years calendar years, depending on date of conversion (because years are counted instead of actual date, so a conversion on 1/1 is treated the same as 12/31). Now just check your email and start tracking! Form over function? Note: Boxes 3 and 5 of Diana’s W-2 report only $40K of wages because health insurance isn’t subject to FICA or Medicare. 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. Brad, regarding interplay between QBI and S corp shareholder-employee wages, really what almost everyone wants to do is simply minimize the shareholder wages. Note: This accounting leaves $5K “leftover” for a shareholder distribution. 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. 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