LLC vs S Corp - 3 DRAWBACKS of an S Corporation - Costs and problems

well hey everybody Rob satrom from feedback wrench calm we help small businesses go from good to great by doing consulting financial coaching SEO and marketing and today we want to talk about what are some of the drawbacks or particularly what are the three major drawbacks of converting to an S corp or doing an S election and we're gonna help you understand a little bit of the dark side of becoming an S corp so as you know one of the best ways that you can mitigate your self-employment taxes is when you start to make income or net profits north of about thirty or forty thousand dollars to do an S election and convert to an S Corp for most businesses this is gonna make a ton of sense because essentially you're gonna have a new tool to mitigate your self-employment taxes those dreaded Social Security and Medicare taxes that total fifteen point three percent of tax on your net income this can really eat away at your profits and when you become an S Corp what happens is instead of a hundred percent of your net profits being subject to self-employment taxes you get to split it into two pieces we we cover this in our our video called the tax difference between an LLC and an S Corp but basically what you do is you split it into two different parts one side of this income will be your salary or your payroll you'll have your corporation actually pay you you'll use a payroll system to do that and then the second part of that income is called the dividend or the distribution that you take as an owner in its most basic sense the dividend is not subject to self-employment tax while the payroll or the salary is now you need to take a salary that's reasonable according to the IRS and that has a lot to do with your net profit overall your industry trends what's just been your history there's quite a few different things that go into it so you should consult a professional to look at your case but if you're looking to mitigate your taxes becoming an S corp is one of the best things that you possibly can do now there's a number of drawbacks when it comes to becoming an S corp and that's something want to talk about today nuance financial is a tax firm that I helped build up and they're based out of Minneapolis they have a great solution an all-in-one shop work for about $500 a month they do all your bookkeeping all your tax planning your tax returns and they just handle everything for you check out nuance financial calm for that but so many accountants don't dive into the full drawbacks that an S corp are going to have so I'm gonna go over that there's really three major drawbacks that an S corp has and just bear with me so the first one you have formalities if you're going to convert to an S corp that means that in order to partake in the tax savings you'll have a tax and legal formality set of Hoops that you're gonna have to abide by and the first formality accounting and bookkeeping to determine the reasonable salary the first formality that you'll have to manage is this tension between a reasonable salary and the owners distribution if you're not familiar with what I'm talking about then please check out the video on YouTube the button right here to see the tax difference between an LLC and an escort the bottom line is that you need to take a salary which is reasonable according to your net profit and a number of other factors this means that you'll want to be on top of your bookkeeping and accounting throughout the year so that you can know exactly how much should be taken as a salary and how much should be taken as a distribution so the first formality is a bookkeeping and accounting system that you can determine and substantiate decisions made to manage that tension between a salary and a dividend or distribution so again check out nuance financial calm for that the second formality is that you need a payroll system for your S corp if you didn't know this the government has spent its Social Security money which means that anyone pertaining in the tax benefits of an S corp will be held to a strict compliance for remitting the Social Security and Medicare taxes because the strict compliance is required it's a very good idea to use a payroll system you don't have to but we just highly recommend it we usually would recommend like an ATP or an Intuit product product like paychecks zenpayroll there's quite a few everyone's out there when you add up the total fees associated with using some of these solutions you'll see that an all-in-one shop like nuance financial might be a good idea but you need to have a payroll system and you'll want to remit those taxes through the payroll system and that's one of the major formalities when you talk to an ADP you know if you're just a single owner S Corp or if you have five or six employees but those fees can start to add up so the the first formality is that you have accounting and bookkeeping then you have a payroll system now the third formality is that you'll have an eleven 20s tax return the S corp tax return is a bigger tax return that you should expect to pay you know between two hundred and fifteen hundred dollars depending on who you'd have to do for it the last formalities is you have some legal formalities remember that there's two parts of all legal entities you have the tax and the legal part so far I've been talking about the accounting requirements and formalities but there are a set of legal formalities that you must abide by as well converting to an S corp will mean that you need a board of directors you'll have shares of stock operating agreements shareholder meetings and a couple other documents that you're gonna have you can go to Legal Zoom comm you can talk to your local attorney there's quite a few different ways to do that but the first big drawback is you have formalities and I tell you what nuance financial com4 you know between three hundred and fifteen hundred dollars a month they'll take care of you but that's the first major drawback so the second drawback of becoming an S corp and these last two ones are huge you're gonna want to pay attention to this it has an impact on your social security benefits it impacts your Social Security benefits in order to be eligible for Social Security benefits specifically your retirement benefits you need to be eligible with enough of these work credits where credits are points that you earn for being employed at a minimum level throughout your life you can only receive for work credits per year no matter how much you earn there's two eras concerning social secur work credits you have those that work before 1978 and those that work after 1978 in 1978 you get all four work credits if you earn at least $250 but in the year 2016 you have to be making about 1260 so if you're making 1,300 bucks a year you're gonna get all four of those credits towards your Social Security so to be eligible for Social Security retirement you need to have at least 40 work credits essentially 10 years of working and earning about $1300 but then to determine the amount of your benefit this is a whole other thing so first you have do you get benefits and now you have the amount of your benefit there's a convoluted system that determines the percentage of your earnings that you've received the average of your highest 35 years of employment why does this matter well for an S Corp and S Corp owners that Social Security benefit is calculated on the salary portion of your S corp income which is why which is the tool you use to save in self-employment taxes so you need to be aware of this if you are doing an S corp to save in self-employment taxes you must prepare by investing so that you hit retirement with what you need you'll have to take what's called that reasonable salary which varies quite a bit and the Social Security limit is 118 5 and 2016 that's gonna be 125 moving into 17 and 18 you need to be careful that you understand that your Social Security benefits will be determined by your salary not your schedule K or your owners dividend or distribution you'll pay much less than self-employment taxes when you reduce that salary but your benefits will be adjusted down the solution is to make sure that you're investing in retirement being financially wise not getting in a huge debt and taking some of your tax savings to prepare for the future by investing I really like Vanguard calm you can go pick the year that you retire and get their retirement funds they have super low fees they're called index funds they're great check out Vanguard com now this is kind of a big deal I highly recommend that you dive into what's called an SMP 500 index or these retirement date funds you need to be investing even better yet if you have a business and you want to invest you can take a look at SEP IRAs 401ks individual 401ks if you're like a real estate agent or a consultant or somebody like that and you're a single owner S corp the solo 401k is one of the best tools you can use out there so the second thing is is that your retirement benefits your Social Security retirement benefits are going to be impacted by reducing your payroll so the third big drawback is that Home Loans and retirement plan contribution limits are tied to your salary so this part that we're trying to make small home loans so when you go to get a mortgage or if you want to put lots of money towards a retirement plan those contribution limits and that home loan looks at your salary almost always so if you're doing a SEP IRA a 401k a profit sure defined benefit plan your maximum contribution is primarily tied to the salary portion of the S corp so definitely check out the individual k the solo 401k or the regular 401k from Vanguard or even ADP they have a great product I won't dive into all the different rules and examples because they change every year but I'll say that the 401k employer contributions now there's two types of contributions employer and employee contribution one the company is making into the account the other it's more like if you work for somebody else and that's tied to this salary portion of the S corp not the schedule k dividend the employer side contribution is often called a match or a profit share side most plans allow you to pick a percentage of the Schedule C business income if you're an LLC or the salary side of an S corp so usually you're gonna do between 20 and 25% of your Schedule C from an LLC or of your salary as an S corp for your that's for SEP IRAs individual 401ks or profit share contributions so take a look at that remember that when it's time to buy a house if you're applying for a conventional FHA loan or a VA loan or something like that you'll quickly realize that the business income needs to be locked down for a period of 2 years before it's even taken seriously and then you'll notice that it's the S corp salary not the distribution that's considered for the regular mortgage like that therefore if you're a homebuyer and you've got house fever and you're gonna be buying a home you should take a cold shower and realize that in exchange for saving thousands a year in self-employment taxes by taking that smaller payroll or salary you're gonna be approved for a lower amount in your pre-approval process so just know that when it comes to buying a home when you've been working hard to reduce your salary side so that you don't pay as much in self-employment taxes you need to know that your lender is gonna be like wait a minute you don't make very much they're not gonna approve you for as much now if you were to not use an FHA or maybe if you're to talk to a different lender that's not tied to the traditional mortgage rules maybe that you'd pay a little bit higher interest rate but then they would probably approve you for more remember whenever a bank is taking on more risk which entrepreneurs are riskier you're gonna pay for that in an in a higher interest rate so remember that while tax planning with an S Corp is huge there are three big drawbacks the first one you've got formalities the second part is your retirement Social Security benefits will be reduced and that can really impact you if you're not careful and then the third thing is when you go to buy a home or if you're gonna make these retirement contributions they're tied to the salary of the S corp and that means you often can't make as big of an investment or buy as much house so again this is Rob satrom from feedback wrench com we hope this is helpful if you're looking for an all in one solution check out nuance financial com if you're a small business owner and you're looking to make the web your best employee check us out at feedback wrench com hopefully this is helpful you

Channel: FeedbackWrench

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Id: Yi37DkCLbkM

Length: 13min 30sec (810 seconds)

Published: Tue Sep 05 2017