In this case, the typical S corporation by dissolving would pay $6K to $7K more in taxes. I think Social Security maxes out around around $108K, right? 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. 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. If you dissolve that S corporation to bump its qualified business income by $40K, that will bump the Section 199A deduction and increase the Section 199A savings… but not by very much. Ideally, most of the compensation could be in the form of deferred compensation. 33k = Blog x 25% = $8250 wages. You really don’t. I’m semi retired, I spend time evaluating real estate deals to see if I want to lend. E.g, the typical S corp saves 15.3% on $50K of earnings or about $8K. This ultimately reduces the QBI deduction. Mad Fientist. That leaves $60,000 you pay out as a distribution to your owner—and on which you pay no employment taxes. 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. For example, say you were running a small S corporation that makes $100,000 and that you want to set $40,000 as your S corporation reasonable wage. Just set your IP address to current unit different country. In other words, the Roth 401(k) rollover money inherits the age of the Roth IRA, either for good or bad. Percentage of Profit Subject to Employment Taxes – S Corp. And this means the person pays about $6,120 in employment taxes. 13,932 people like this. But to really come out ahead on this, you want to save your payroll tax savings. If so, did the IRS give any pushback or try to impose the 10% penalty? Note: Self-employment taxes replace the Social Security and Medicare taxes that employees pay and basically work the same way. The taxpayer pays too much payroll tax for the relatively modest tax deferral benefit they enjoy. E.g., if the total profit equals $100K, $8250 is *probably* too low optics-wise. Most personal finance advice is geared towards people retiring in their 60s or later and doesn’t apply to those pursuing early financial independence. (Not counting Roths) Would an S-Corp be a good fit? For these states, you need to double-check your math. Also my CPA told me I only have to file every 6 months, but I read somewhere it should be every quarter. Take the case where a sole proprietor earns exactly $100,000. Learn about investing, tax avoidance, entrepreneurship, travel hacking, real estate, and all things related… Just set your IP address to purine different country. And another chunk goes to Brad the shareholder… maybe that’s the other $45K. Community See All. I.e., maybe you should consider yourself a bank. 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. If your business is structured as a sole proprietorship, you wouldn’t receive any Section 199a deduction because you earn too much to qualify. Regarding the 28.5714% thing, if S corporation wages limit the Section 199A deduction, you optimize with that percentage. Now just check your email to get your spreadsheet download link! Annually. 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. That’s often about $500 a year. If what a software consultant really does is programming or design, that’s probably not really per the Section 199A deductions a “consulting” activity. 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. NO Spam. Someone working part-time would logically earn less than someone working full-time. 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. 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? But here’s the way this works now (and the way it’s worked for years). To maximize your savings, you want to pay yourself as little as possible. But say they did.) Jaco, Good issues to raise. I solve taxes are calculated supported on ip address and not on transport address. There’s another benefit of having an S Corp that’s worth mentioning…. or. 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. It would not surprise me if you can save substantial amounts with an S corporation. Accordingly, the Mad Fientist thought it made sense to cover this tax-avoidance topic before the year ends. 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. Mad Fientist. Minimizing shareholder wages also minimizes the FICA and Medicare taxes paid directly or indirectly by the shareholder. I hope it’s okay to provide this link but if not, apologies and please delete: https://evergreensmallbusiness.com/subchapter-s-election-timing-tips-tricks/. SS stops at about $132K, however, medicare costs are ongoing. BTW, if someone only worked part-time, that matters in the reasonable compensation calculus. Regularly S corporation owners go ape when setting their salaries. When I started the Mad Fientist, I didn’t do anything special to start my “business”. But… not if those gains and total taxable income are less than $78,750 (again, 2019 values, MFJ. But it is only 8.25% of total income, far below even the 40% you suggest is borderline. Like Brad, I too would like to learn more about the interplay between S-corp wages and deferred compensation. 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. Your email address will not be published. The work on the book having been done years ago, the royalties are completely passive. Why? But they aren’t more important. 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? So if you pay out $285,714 of $1,000,000 in profit as wages, your Section 199A deduction equals either 50% of $285,714 or 20% of ($1,000,000 – $285,714)… either way, the result equals $142,857. Really late, but revisiting because it’s tax time…. Website . Has anyone done a t401(k) to Roth 401(k) conversion to beat the 5-year rule and make their ladder shorter? (I received royalties for “Quicken for Dummies” for two decades… and I continue to receive royalties for “QuickBooks for Dummies” even after two decades.) Tip: Usually S corporations don’t work well for side hustles if you have another W-2 job. 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. Since that ‘consulting’ answer I gave you, the IRS issued proposed regs… and software programming doesn’t count as consulting. 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! However, I cannot find any confirmation that Roth 401(k) converted funds are treated the same as vanilla Roth 401(k) contributions. But say the S corporation provides $20,000 of health insurance and a companion health savings account. or. My first reaction was that the S-Corp gets trickier when income is high but not high enough to phase out of the QBI. Bummer… I also cannot in good conscience claim to be hiring my wife/kids (a strategy my former accountant was pushing). 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.”. Second, you should know that two states—Tennessee and California—make the economics of an S corporation option tricky. 14,214 people like this. 4. 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 may have a one-off increase of business income by 100% in a couple years (long term contract payout), so does that change the calculus? For a married couple, the 15% marginal tax bracket goes pretty damn high: $75,300 in 2016 (which would also include a $12,600 standard deduction AND $8,100 in personal exemptions). Specifically, could an S corp or other LLC be set up for a business that barely turns a profit? First, if you’re in business of hard money lending, maybe activity should be reported as a business and not as portfolio income. Because the Section 199A deduction equals the lessor of the qualified business income or the taxable income. But that doesn’t result in a higher Section 199A deduction. So his QBI equals $100K. School bully type then? I’m probably missing something. That riddle…what wages do you pay yourself as the business owner? 24k – standard deduction I own an S-corp. If you have an S corporation making (before shareholder-employee wages) about $90K (this number distilled from your comment), you extract this profit in two ways: A chunk goes to Brad the employee… maybe that’s $45K. Okay, maybe that works for some taxpayers. As I understand it, you can only put in 25% of wages on the employer side of the 401k contributions. The payroll tax savings for most businesses won’t make up for the “tax cost” of the reduced QBI deduction. Success! But to determine how much income tax, you need to combine the business profits with all your other deductions: self-employed health insurance, pensions, itemized or standard deductions, etc. Obviously, the S corporation tax strategy delivers substantial tax savings. Would love your thoughts…. Say she pays herself $40K in base wages and then also provides $10K of health insurance for her entire family. 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. 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. Thanks so much for the informative post. Withdraw converted amount from Roth IRA, which is treated as a Roth contribution. Some forums can only be seen by registered members. Website . That was only for illustration. Not Now. The bottomline: Your payroll tax savings in this case equal about $5300. Brad, regarding interplay between QBI and S corp shareholder-employee wages, really what almost everyone wants to do is simply minimize the shareholder wages. If both of the example business owners above have a $10K self-employed health insurance deduction, a $15K pension deduction and another $25K of personal deductions–so $50K in total–that would mean $50K of income subject to income taxes. But here’s where a second trick comes into play. BTW, in both the sole proprietorship and the S corporation format, you pay income taxes too. Regarding 199A, I actually asked you about this before, and due to the majority of my ‘consulting’ involving actual software design/programming, you suggested I probably wouldn’t qualify: (from your comment) Yes, many taxpayers get away with this. Jaco operates as an S corporation and breaks the $100K of profit into $40K of wages and $60K of distributive share. Note: When you make a late election, you need to invoke the correct revenue procedure and follow its rules. My personal experience is that they are rare. I have blog income and book royalties. They don’t, for example, set the salary to some reasonable level. Add nontaxable fringe benefits like health insurance and employer pension contributions. Convert t401k to Roth 401k within a 401k plan during periods of low income. This is incorrect. 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. Convert portion of tIRA during period of no/low income (taxed at reduced rate) to Roth IRA. 4000 – 1099 worker But the savings come with extra costs and risks. The salary you pay yourself reduces your qualified business income. In 2019, that limit rises to $132,900. 5. There’s another benefit of having an S Corp that’s worth mentioning… If your business makes a lot of money (i.e. Say you also run either a SEP-IRA or a solo 401(k) plan that provides a 25% employer match. Success! Create New Account. (Read 34159 times) milesdividendmd. I’m still a little confused. However, suppose this person incorporates their sole proprietorship and makes an S election. The Mad Fientist on specific identification of shares. Further, this sculpting might be especially compatible with working toward FIRE through aggressive saving and investing. Yes, Steve enjoys a higher qualified business income because he doesn’t deduct wages. or. 3. E.g., if the S corp paid David the employee $30K in wages subject to FICA and Medicare… and then it provided $10K of health insurance and HSA to David and his family… and then it provided a 25% SEP benefit of $10K, that probably works. Presumably, hundreds of thousands of S corporation shareholders pay more than zero but still unreasonably low salaries. The kit has you set up a Texas LLC ASAP… and then you would make the S election effective for 1/1/2019. That gambit also basically never makes financial sense. How to reduce taxable income is slightly more complicated. (By staying a sole proprietor you maximize your QBI to $80K… ) But the answer to this question is probably “no.” Assuming you are married and take the new standard $24K deduction, as a sole proprietor, you would get a Section 199A deduction equal to roughly $5200 which would save you only about $624 in taxes. 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. Let’s say Diana owns and works in an S corporation. In a sense, to say this another way, you now have *two* good reasons to push down shareholder-employee wages. Great article, as I was just recently researching this topic – thank you! 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. Success! Forgot account? The IRS audits about 12,000 S corporations a year, and nearly 6,000,000 S corporations exist. Brandon talked about the ~28.57% of business profits to maximize the QBI, and you talked about keeping wages down to minimize employment taxes, but there is some consideration to 401k contributions as well, right? In this case, the corp treats both the $40K and the $10K as wages and reports $50K in box 1 of Diana’s W-2. But to clear up this confusion, I am not suggesting 40%. BTW, sort of related: People sometimes bump their S corporation compensation only to bump their pension contributions. 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