Hey, guys. Toby Mathis here. And today
we're going to talk about the differences between sole proprietorships, S-corps
and C-corps for running your business. And I'm just going to do a basic
kind of contrasting between them all and the pros and cons,
and I'll probably draw it out on a whiteboard so that you guys can see
it visually as well as understand it. So I'm going to I'm going to start
kind of at the 10,000 foot view and hit a few things like number one,
there's always going to be an issue about liability that we have to address
and people pretend like it doesn't exist. Sometimes they've set up a business, they'll say,
I'll just be a sole proprietorship, they'll file a debate somewhere
and they think that they have protection. Anything that goes wrong in that business
is you. It's personal. So, you know, I used to use this example for people through the medical profession,
doctors and staff. They had some high incomes and they would start investing
and they'd go buy a little house. Maybe they'd buy a house in Indianapolis
or Kansas City or one of these places where you get an inexpensive house,
maybe they buy a $50,000 house and they say,
What's the worst that could happen? Honest, get some insurance and make. The worst that could happen is that you have a wrongful death on that
that exceeds your your your coverage, which most likely will,
if it's a young person, and then they start garnishing you
for the rest of your life until it's paid off with all the attorney's fees
and all the costs. I actually had a individual come up to me
during an event that I was teaching. This was
a I caught a little old lady, right? But she was a gal that she was in her late
seventies, early eighties. And it was kind of surprising
to see somebody in that category at a real estate asset protection event. And I asked her
what was going on, and she said she had gone through the process
and she lost 15 properties and her and her and she ended up going bankrupt
just but it put a fine point on it because of a liability occurrence
that was supposed to be covered by insurance and that her attorneys said
would never happen. And she ended up she called it dominos is they foreclosed on one property,
went to the next, foreclosed on it. And by the time that you added it, all the sheriff fees
and all the legal costs and all that, there's almost nothing
when you force the sale. Now, what does this
have to do with the business? Because the same principles apply. I open up a plumbing business
and I accidentally flood out somebody's house and I actually a homeowner from
that had that happen, it was over $1.5 million for the damage because a pipe was not properly. They didn't put the glue and it came apart
while the individuals were out of town. And so for the better part of four days, water gushed into the house
and destroyed the entire house. Well, who's liable for that? Well, you are if you're the proprietor. And a lot of people
just go out there, do it, they get minimum insurance because it's they probably wouldn't qualify
for higher deductibles. They're not they insurance companies are
going to take on that risk and also money. Sometimes they don't even insure
they go self-insure. So liability for that has to be addressed. And so I'm just going to be real
blunt with you guys. If you are doing business
with third parties, I don't care. Like until you had this happen to you,
you're never going to fully appreciate it. People could sue you for just
about anything, and in business they will. Even if you have a worker
and all of a sudden they claim that they were an employee and you discriminated against him
or you wrongfully terminated him. It can be hundreds of thousands of dollars
if not higher. So what do we do? We use an entity. You pay the state. It's no different than if you watch the
the movies of the old mob. And they say, you know, do you want
do you want your storefront protected? Make sure your windows don't get broke. And if you didn't pay them right,
what did they do? The windows broke, but you pay them
and nothing ever happened, right now you have protection. The state offers that protection for you
from a liability standpoint, you just pay the state and they say, Hey,
nobody can go beyond this box. You do a few things. You pay us, you make sure you meet some formalities,
some basic stuff, then you get protection. It's called liability protection. That's number one.
You got to make sure you do that. So I'm just going to hit that
right off the gate. If you are somebody who's operating
as a sole proprietorship in your name and you're selling goods and services
online, or you're doing business with third parties or you're a lender
or you're whatever, fill in the blank. The liability is virtually unlimited
and can follow you around until your end of day. So make sure that you're putting a box
around that liability by using, at a minimum,
an LLC. It's got a limited liability company. So I'm going to contrast sole
proprietorships, escorts and C Corp's. But keep in mind,
in the back of your head, you could be an LLC and be taxed
as all three of those. Any of them is what I'm saying. So I could be an LLC disregarded
and ignored, taxed to my personal account. I could be an LLC tax as an escort,
but I could be an LLC taxed as a C court, or I could be an escort
or I could be a secret. It's that simple. If you have partners, then when I say sole proprietorship,
you could just say partnership status. It's the same thing. So the number one, and I'm just going to put this up on a screen,
put myself in the corner. So we need to be cognizant of liability in all we're doing
is if you have a business and you have a person here,
hey, here's me. I just want to put a box around that. We also because we do that,
we also get some protection from stuff that can happen to you. Like if you're driving in a car
and you get into a car accident, you want to make sure they can't just go
in and take all your business assets too. During any situation where
you're finding yourself in a lawsuit, you want to make sure that that stuff
doesn't handle it, doesn't happen. So we want to make sure
that there is a box around it. And that is that's our friend, the LLC. It could be an INC, you know, straight up corporation,
but you want to make sure that you have something
that creates a barrier around you. Now we want to talk specific
about sole proprietor. Let's make a little line here. S Corp and C Corp. And I'm just going to do kind of like pros and cons. Oops, we'll make our cons into read. All right. So I'll write these out. So let's go over why
somebody might be a sole proprietorship. Number one, you say, Hey, Toby, so bad,
why does anybody do it? And the pro is because it's easy. It's the default. If I do nothing else,
I could just file a schedule C on my 1040 and I magically a sole proprietorship and this is where the tax comes in. And in the tax world there's an adage
which is if you are an individual, I'll just put an individual up here, you earn, you're taxed, and then you spend on your business, you earn, you spend and then you're taxed. Maybe I'll do tax. There we go. So it's that little difference
is the spending moves up that's all, and becomes
something called a deduction. So going back to our friend,
the sole proprietorship and I'm sorry, that's behind my head
here, I'll do it like this. There we go. So you guys can see it in the sole proprietorship. We have a Schedule C
and we're going to take deductions. And so we are going to spend
and we are going to get business expenses,
which is this little guy right up here we're going to spend and we're going to lower our taxable income
so your taxes will drop if you're doing that sole proprietorship
and you're doing it right. The cons of a sole proprietorship in the meantime is unlimited liability. If you don't set up an LLC and that's a pretty big one. Huge. It's too easy to create a big,
massive liability problem for yourself. And I've actually seen it a client,
they tapped somebody, they were in there, their business van. You know, they had their their contracting business
on the side of the band and they tapped somebody in a
in a bank line. And almost two years later, they get sued. So for this lawsuit
and this is literally what she said, just a tap, somebody I got out,
it looked as said, hey, everything okay? There's no
mark, there's nothing on the bumper. And the guy was like,
no big deal, don't worry. And her kid was in the back seat
and she's like, oh, okay. I just I'm sorry. It is rolled India. It was it was there in the line at a bank. So it wasn't like they were moving
very fast where of course, two years later, it's a catastrophic injury that did
massive amounts of damage to the child and they're suing for seven figures. And who do they sue? They saw the name on the side of the van.
So what did they do? They thought that there was
bigger policies or whatever. I mean, lawyers are notorious. They go after the deep pockets. They think, oh, business, maybe they have better liability policy,
maybe there's something we can get there. So they went after
but by herself, a lawsuit. So you want to make sure that you're limiting that liability
so that at worst case scenario, it's stuck inside that box,
inside that business. So that's one of the cards. The other con is an increase
in audit rates because it's easy it's really easy
to defraud the government. So let me give you some stats here. You see, you're a business making $100,000
a year and your sole proprietorship, according to the last available data
in Publication 55 and it's usually table 17 below,
they just discontinued it for this year. But the last year we had your audit
rate was 1.6%. Your audit rate as an individual
otherwise is about 0.1%. Your audit rate as an escort is 0.2%
most years sometimes goes down to 2.1. It's right there. In other words, your audit rate is 1,600% higher than a typical person
and 800% higher than our friend. The escort, which is,
you know, one of your options here. So your audit rate skyrocketed, but
that's not even the most important number. The most important number is that the
you lose 94 to 95% of the time if you're a sole proprietorship
because they're easy. The the the formality requirement for any business is identical. Whether you're an S corp, C Corp sole proprietorship partnership,
it doesn't matter. You have to track your numbers. So proprietors are notorious
for not doing that because it's so easy to operate as a sole proprietorship
that you just don't realize that every business call has to be tracked, every business mile has to be tracked. You now have entered the world of
you have to document that something was a business expense
or it didn't happen. And I pushed this up
so I can see it a little bit better. Sorry if that makes some
of that stuff go away. So this is
where people get into a lot of trouble and they lose
almost all the time in the IRS knows this. So where are they going to go? They're going to go where they get paid
the most so they lose like crazy. Last one, because you're sole proprietor, you get to pay your federal taxes, your state. Plus you pay both sides of something
called old age disability survivor's insurance, plus Medicare, 15.3%, which is also called the self-employment tax. No bueno on every net dollar, every dollar that you end up netting you make,
you're going to pay not only your federal income tax,
not only whatever your state is, but you're also going to pay
both sides of social Security. And they call it a self-employment tax. The reason they call it
a self-employment tax is because every other business,
the business pays half and you pay half. And in some cases it doesn't even exist. Like I'm profits
out of an escort or a C Corp. There's no there's no Social Security. So it's just for it's just for you
and the self as the sole proprietorship. So those are some pretty major cons. Now let's go to our friend,
the S Corp and the S corp. I'll just say that as a pro is it eliminates I'm just going to say 60% plus of self-employment taxes. And that's
because you take a reasonable salary. It's usually about a third that you take is a reasonable salary
and everything else that you take. So you take a small salary
out of your business because you're considered
an employee of an escort. And any of the profit
that comes down to you is not subject to self-employment tax,
which is really, really beneficial. It avoids 15.3%. The number when you look at the
because part of its deductible is 14.1%. But just think here, I made 100,000 bucks, paid myself 40 and I'm not even talking
about using a41k and deferring a big chunk of that
and all that fun stuff, which you can do. But let's just say you paid yourself
40 to $60000 a profit, 14% of $60,000. I'm trying to do the math. My head is somewhere around 9000 bucks that you get to keep
put it in your pocket. That's the difference
between that structure. And, by the way, if you're an LLC, you can become an escort
with one page of one document. It's called a 2553. You only have to do a bunch of other
stuff. Also,
the lower audit rate, it's really low. It's a flat like 0.2%. Some years just 0.1% as corp
generally don't get audited. But we know why they get audited
when they do and it's because they took distributions
without taking a salary. So you have a salary requirement that's then, you know,
that would actually be a I'll put that as a kind of the safe
salary requirement, but you have a salary requirement
and then the rest of it, whether you take it or not,
it's can be taxed on your return. It flows on your return. So the net profit, whether you leave it
in the business or take it out, it's being taxed to you. And therefore you could take money
out of the escort really easy in the SE Corp, in the C corp is
is really important is they're both considered an employer
and you're the employee. You can't do that
with a sole proprietorship or a partnership
in which you're a partner. And as a result, you get to do something
called an accountable plan. And the reason that's important
is because now your benefits like remember I said the cell phone,
you have to track business and personal. You don't have to do that with an escort. Did it benefit the business grade? I can write out 100%, so I'm just going to call it
tax free fringe benefits plus the end. And then I'm just going to put plus,
you know, you can get all sorts of other benefits
out of it. You can reimburse mileage,
you can reimburse the administrative use of your home. You can use them to go to ADR
and reduce your taxes even further. You cannot do that with the sub ridership. You can't do that with the S corp. You can also do that with the C Corp,
which I'll go over in a second. But those are some pretty good size
benefits. And because it's an entity, you get limited liability. So we've isolated our ly our liability. This is why serious planners
almost never use a sole proprietorship. They almost always use an escort. But most accountants are going to use
an escort because this is such a huge one. This eliminates the self-employment tax. They tend to gravitate towards the
the escort. I like C Corp's to for reasons
you'll see in a second but but that's why they gravitate. Now what are the downsides as well? You have to file a separate tax return. It's called 1120 S It's the same information
that's on your schedule. C It's almost identical,
but it's a separate tax return. You know, some tax
preparers charge differently. It's, you know, they might say, hey,
I'm going to charge an extra such and such to do that return. It's just, you know, it's the juice worth
the squeeze. You look at it and say, How much did
I save and all this, you know? So I have an extra 500,000 bucks. Whatever it is to do that return,
I would have had to do the same thing on my personal return as a Schedule C,
but let's just assume, hey, it's going to cost you a few hundred bucks
more, up to a thousand, 2000, whatever. If you have a crazy account
and just charging the hell out of it, it's still better if you got that $6,000
extra tax deduction. Right, like or tax savings, I should say. Deduction. And then plus, you're going to get the administrative office in your home,
which allows you to write off about 20% of the expenses of your house,
depending on how much space you're using. If you're using a full room and like it's
a three bedroom house, it's probably gonna be about 20% of all your expenses
in that house you can reimburse because the business is using it. And by the way, when it reimburses you
these things that you don't have to report it, it's nontaxable,
it's in countable planets, employee benefit training thing,
if there's any other negatives there. I mean because that's the whole thing is
sometimes they say the formalities, but and I guess I should say this
that if you're doing an escort versus a sole proprietorship
without an entity, you're going to have some state
filing fees, you know, so depending on your state, you may have a, you know, a little bit of money
that you paid to keep that. Remember when I said, you're
protecting the storefront, you're paying you're paying someone to protect it,
you're paying the state some protection. So we'll just be fair. There might be some state filing fees
there. You know, depending on your state,
it could be 50 bucks. It could be more. If you're in California, for example,
if it's an LLC escort, C Corp, whatever it is,
maybe 800 bucks is the minimum, but it always varies
depending on your jurisdiction. Some are really low,
some are a little bit higher. But you're going to pay that. You're going to pay that regardless. I think because I've never set up a business
that does business with third parties without putting a box around it,
you're going to incur that, but I'm going to allocate that to the S corp
just so I have some more cons on there, and it's not all pro pro with the C Corp. Let's talk about this. No salary requirement. In other words, in an escort,
when you make money, technically,
you only have to take a salary if you're distributing
the money to yourself. So if you have net profit that's not distributed, you don't
technically have a salary requirement, but in a C Corp,
there's just no salary requirement. You could get compensated
with just fringe benefits. And the accountants that are losing
their mind at me right now I'm sorry. There's there's nothing there
that that that requires the salary. There's plenty of folks
that work for a dollar or work for nothing or work
for the fringe benefits, especially when you move into the nonprofit side,
which is the same rules. It's yeah, you don't have to
you don't have to take it. You could work for the fringe benefits
and be happy with it. So there's no salary requirement. So the C Corp can make a million bucks. It pays a flat 21% tax. So you could be making a
you and your personal realm might have high income
and then you have a business. You may be better off
running that business as a C Corp and keeping it that flat tax
because it's cutting your tax in half. I mean, in many
cases, that's exactly what it's doing. It's in even worse,
depending on what state you're in, you might be better off
keeping it out of your state, letting the business run
outside your state, and just letting it accumulate money over time. And if especially if you're
growing business, you may want to do that. The other pro obviously is limited
liability, just like its brother, the s corp and you get lots of tax free fringe benefits. There's a extra benefit of a C Corp, which is the medical, dental vision expenses or 100% reimbursable
and tax free to the recipient. So if you have, let's say it's a small mom and pop
because of you, you can't discriminate against employees
in this scenario. But let's say that it's a small, closely
held business. You have a spouse
that works for an employer and they have decent insurance,
but it's high deductible and high co-pays and it doesn't cover everything. You could have a C Corp on the side
that's literally reimbursing you every dollar that you come out of pocket. It's not taxable to you
and it's deductible to the company. So you remember the company,
this guy up here, that spending could be medical. We all make it. So you actually see it
medical and it's in it. So your tax goes way down. So your tax could be nothing, especially
if you have high medical expenses. So what are the cons of the
our friend, the C Corp? Well, you have a separate tax
return called an 1120. Most accountants will tell you
there's a double tax because the company makes profit and it's taxed at 21%. In order for that to come out to you,
you have to pay a dividend. But dividends are taxed at zero,
15 or 20%. They're taxes, long term capital gains. So if you're depending on what your tax
bracket is, you could be letting it sit in there
and then you might have a dividend someday and could count on one hand
how many companies I've seen pay dividends but closely held. They're usually trying to expensing get it down to zero
or if they're accumulating money, they're not going to pay it out
as a dividend. They're going to continue
to grow the company. And there's other ways to get money
out of a C Corp or use it for benefit. You're growing that, but let's just say, hey, I want the money,
I'm going to pay it out of the dividend. Then it's not like you get taxed at
your ordinary rate, you get taxed at this. In some cases it's zero. It's paying you a dividend in a year that
you don't have a bunch of other money. Maybe it's a down year or something
like that. Married filing jointly, you're
making 60 grand or something like that. It could pay you an extra 20
some thousand dollars, $28,000 at zero. So it could give you some of that profit
in that particular situation. What else is the bad side? I guess you do have an elevated audit
risk. If you have more than $250,000 of asset on your or a net value on your balance sheet. So if you start having a balance sheet
that's got millions of dollars, the audit rate doesn't go through. It's not like a sole proprietorship,
but it starts going up. You get over $10 million
and you have a high audit risk. Big companies get audited more often than just about anybody else,
and that's because they're a big company. And if you're a big company,
you're making $10 million a year. That's 10 million in your balance sheet. So that's probably a,
you know, 50, $60 million company there. You probably have a CFO
and you have your own accounting. You already know what's going to happen. It's going to happen
once in a while, like every 20 years. You probably should be prepared
to have an audit as opposed to an escort,
which is every 500 years. Right.
But you look at those things anyway. If if by the way,
if you have a small C Corp, it's fractional it's really, really small audit
rate. It's it's in the toilet. It's
there's just not much there. It's like the escort to the IRS. Again, remember these little guys up here,
you earn tax spend. It's really easy to hit this person
right here. This this guy is a good target. This one not such a good target
because all they got to do is, oh, I spent it over here. Oh, you can't write that off. I spent a bunch of money over here
that I can. And it offsets, you know,
so they they tend the IRS is is interested in getting money in
and benefiting from that money. So it's like they're probably not going to go after the business
if the business can still write it off. You know, they start auditing them
and they come back and they go, Oh,
we could have written this off too. We forgot to call that sandbag. And that does happen
where you didn't realize how much stuff you actually could have written off
and you wrote off only part of it that the IRS comes along and you end up
they end up writing a check. That does happen. And it happens actually quite often. I've run across so many of those folks
and we experience it once in a while. We don't have too many audits. We do about 10,000 returns here. We had, I think a dozen last year. It's just a really small amount, but it's always fun when they do
and it makes you really look at everything and you're like,
You could have written that article, written that you could have written, that you could read out, and it ends up
being a net benefit to the client because it forced them to take a closer
look at their accounting. So anyway, that's something to consider. So end of the day, of those three of those
three really sole proprietorship comes in in
third is just not really very good. I would say that the C Corp
just by a slight margin comes in second because most people
that are running a business and need to take a salary,
they need to live off of it. The ease and use of getting money out of an S corpus
can be that little extra benefit. It always depends. We love C Corp here in my firm. I love I love working with
especially in multiple structures. They I have a real estate investor
that also has a business. I'm going to use the C Corp
most of the time. But if I just have a I'm
setting up a new business and I, I rely on it to take money out and I and
that's how I make my living, most folks. And I'm going to say that most accounts
are probably going to agree with me too. You usually look at that SE Corp because of the avoidance
of the self-employment tax and because you don't have
a double tax on the profit that we're looking at that route. If it
if you need that money to live off of and you need it consistently, then that's
probably the route you're going to go. I hope you learn something. If you know anybody that's in business and could benefit from this information,
please do share it. And then also keep in mind
that every month we teach a tax and asset protection
course, we specifically gear them towards real estate investors. But the principles go across
all boundaries. Feel free to join us for that. It's absolutely free, generally speaking,
or teaching it a couple of times a month. And we
we really do encourage you to do it live. And so we give huge incentives and it's ridiculous offers to those
that are actually live on it. Nobody else gets access to it,
even if even it there's no recording. But even if there was a recording,
we don't play games like that. No. If you spend some time educating yourself,
then there's going to be benefits for you. Hope to see you in one of those classes. Otherwise, share this with people
that you think would benefit from it and leave me comments. I love seeing what you guys have
to write, so thanks again.
