Tax Differences EXPLAINED: LLC, S Corp, Partnership, Sole Prop

in this video I'm going to show you no matter how your business is set up whether it's a sole proprietorship an LLC an S corporation or even a partnership how much tax you might owe for each entity type how to make those tax payments and even when those payments are due so you don't have to worry about late payments or any other types of penalties okay but before we jump in if it's your first time here my name is Navi Mirage I'm a CPA that teaches entrepreneurs how to save thousands of dollars in taxes I do that here on social media but I also do it in a more easy to understand and comprehensive manner through a course you can find those details on my website which is navimaradcpa.com but for now if you get value out of this video consider subscribing to the channel or perhaps liking it and sharing it with a fellow entrepreneur so here's what I would like you to do when we're talking about this is um try to think back to when you were an employee okay when you're an employee you got paid by your employer every two weeks or so right and we when you received your paycheck federal income tax Social Security tax and Medicare taxes were being withheld from your paycheck and you were receiving the net amount of that paycheck right that amount was either being given to you physically with a physical check or most likely direct deposited into your personal account now of course if you lived in a state that had state income tax then the state income tax was also withheld from your paycheck um as well and not given to you well behind the scenes your employer was actually holding on to that money right they call it Inc income tax withholding so that money was withheld from your check and instead of paying it to you and every two weeks or so what they would do is every two weeks or so you your employer keeps that money in their business account and then sends that money on your behalf to the federal and state governments well now that you are a business owner no one is doing that for you right so it's now your responsibility to estimate your taxes and pay them each quarter but the problem is no one's really teaching you how much the estimate or how to pay those taxes uh which again is is what all this video is all about so um let me transfer over to my a spreadsheet that I created to kind of cover this for you and I'm going to break this down for you so that you can finally understand how this works okay now I know you see a lot on the screen here but before you you know Panic or freak out don't worry I'm gonna explain all this to you so let's kind of go through let me give you sort of a layout of the lane here what we're looking at so these different colored columns are just saying hey in this light blue color I'm saying this is the scenario if you're a sole proprietorship that means you're just out there doing business you didn't form an entity or anything like that with your state you just started doing business or it could mean that you formed a single member LLC that's an LLC with only one member on it and by default single member llc's are taxed as sole proprietorships okay in the second column this sort of purple color this is a scenario where you've elected to have your business taxed as an S corporation so in order to do that you formed an LLC perhaps single member or or multi-member um or you file or or you you formed a corporation a C corporation and then you elected uh with the IRS by filing a form called form two five five three you'll be elected to have that entity taxed as an S corporation that's what this purple color column represents and then over on the right this is um a partnership exam example so businesses that are taxed as Partnerships though so your taxes are Partnership if uh even if you don't have a formal agreement if you are two different people doing business together you are now a partnership or you may sort of officially created a partnership by filing or forming a multi-member LLC with your state and those two members on an LLC by default will have it'll be taxed as a partnership all right so that's what these three columns are sole proprietorship S corporation partnership so what I'm showing here is in each one of these examples there was Revenue so you earned a hundred and twenty five thousand dollars of Revenue or sales in your business right so you sold whatever amount of products or you performed whatever types of services and all your customers for the year they paid you 125 Grand and then obviously business expenses I'm saying this is things like advertising and marketing uh you know software fees um things like of that nature other Tax Strategies writing off home office cell phone things like that those were your business expenses and you land at a hundred thousand dollars of profit right you can see that's the same across all three of these different types Soul prop S Corp and partnership where things start to differentiate is um let's now instead of covering all three at once let's cover them separately so Soul prop what happens here as a sole proprietorship you mainly pay two types of tax you pay what's called self-employment taxes which is Social Security and Medicare and you also pay federal income tax if you live in a state that has state income tax you got to pay that too all right so let's break this down a sole proprietor has to pay um Social Security and Medicare taxes as both the employee and the employer okay because a sole proprietorship doesn't get some of the benefits that an S corp has so how this math works is if you take a hundred thousand dollars and you multiply it by 6.2 percent and then that's the employee portion of Social Security and then you take 100 Grand and you multiply it by 6.2 percent again for the employer portion the total of that is 12.4 percent and therefore the math on that's pretty easy right 100 Grand times 12.4 percent is twelve thousand four hundred uh very similarly the um business profit again 100 Grand is multiplied by Medicare you pay Medicare as an employee and employer as well that adds up to 2.9 percent so the 100 Grand times the 2.9 percent is 2 900. so in Social Security and Medicare taxes alone you're going to pay something close to fifteen thousand three hundred dollars all right um federal income taxes what happens here is your 100 Grand that you earned in profit is going to flow through the tax brackets and I'm gonna show you that here in a moment but that's going to flow through the various tax brackets and your income is going to be taxed at different tax rates and as an example I'm just choosing and again I'll elaborate this on a second like I'm just showing this is a single person so not filing married filing jointly but filing single um there are federal income tax on making 100 Grand might be something like 10 374 dollars okay now a lot of you for a state you might be in a state that doesn't have state income tax the reason why this says fixed or graduated is because some states have a flat tax where they just say hey all of your income is taxed at three percent and other states have what's called sort of a graduated tax so very similar to the federal tax system they have different levels of income are taxed at different tax rates so for example the first five grand of income might be taxed at two percent then the next five grand might be taxed at three percent and then let's say ten thousand on you know going forward is you know seven or eight percent so forth and so on okay again I'll come back to the details of this in the in a moment but I want to run through the S corporation example next okay so same thing happened here no no point talking about this part anymore but what happens with an S corporation is you take your um 100 Grand of profit and you split it into what I'm calling two buckets without what I mean there is you have to pay yourself a reasonable compensation for your services that you provided to your S corporation I'm just making this number up for now I'm saying it's forty thousand dollars okay so in this example let's say your name is John John's reasonable competition is 40 Grand the remaining money the sixty thousand dollars that can either stay in the business or it can be taken as a distribution so um John can pull that money out of his business account and take that money as a distribution regardless if John takes that money out of the S corporation or not they're going to have to pay federal and state income tax on it okay let's stay on the topic of Social Security and Medicare tax for a moment though the strategy here with the S corporation is that John is going to pay social security and Medicare tax on his 40 000 not the hundred thousand like it was over here with the sole proprietorship okay so you take the 40 000 you multiply it by the employee rate 6.2 percent so John's paying 24.80 in Social Security tax John's employer which happens to be his own S corporation is doing the same so on 40 Grand times 6.2 percent John's employer so whatever the name of John's S corporation is is also paying 20 40 sorry 2480 in Social Security and Medicare taxes I should say Social Security taxes Medicare is different right 40 Grand times the 1.45 is the 580 and the same thing on the employer side of things okay so you can see the potential sort of S Corp tax savings here is the difference between fifteen thousand three hundred and six thousand one twenty those aren't the exact numbers but this is just a general explanation of how this stuff works but you know if you're trying to calculate how much money can an S corp save me this is the maximum sort of uh tax savings you could sort of received using these numbers okay I'm going to come back and explain why federal income tax is a little bit different here because remember the business the business still made 100 Grand in profit so you might be wondering well why is the federal income tax a little bit more we'll come back to that here in a second state income tax I'm just putting it as five grand we'll elaborate that on on just in just a moment okay let's go look at the partnership here okay partnership same thing the whole partnership brought in 125 25k and expenses 100 000 of profit but you know you gotta split this profit between two different partners right and let's just assume they're 50 50 Partners so what you might notice here is that this kind of works the same exact way as the sole proprietorship does just with less money so partner one is going to get 50 Grand right half of 100 is 50 000. partner one is going to take 50 000 times 12.4 because they're the employee and employer and pay sixty two hundred and then 50 000 times the 2.9 because again partner one is the employee and employer and is going to pay 1450 between Social Security and Medicare taxes partner two it's the same exact thing right they also made 50 Grand you multiply it by these percentages here and that's how you get to these numbers if you look at it it makes sense right A partnership it's kind of like having two different sole Proprietors come together and that's why these numbers is exactly half of this number and that's why this number is exactly half of this number okay so you see the total here paid if you add these two together is 15 300 just like it is here all right and now here down on the federal income tax again I'll elaborate this on this a little bit more in a second it's 50 Grand that's going through their federal income tax brackets and that's why this is so low it's it's 3044 and then um the state income tax same thing I'm taking fifty thousand dollars multiplying that by I think five percent and that's how we're getting to the 2500 okay let me take you through that here um a little bit further with the federal income tax so let's start with the sole proprietorship again so I said a hundred grand um is going to pay ten thousand three hundred seventy four dollars in federal income tax well on a separate screen here um I have that number for you so what I want to show you is I just went to this calculator and I'll put this in the description below if you're watching on YouTube this is uh by Ameriprise and I'm saying hey this filing status is single right they're not married and I put here eighty thousand dollars in wages I'll come back to that in a moment as to why it's 80 000 and not a hundred so when you put single and you put 80 grand the eighty thousand dollars is going to flow through these tax brackets right this is something people get confused by they're like they might look at these tax brackets and say hey I made um 80 or a hundred thousand dollars so that means all my tax all my income is being taxed at 24 no that's not how it works it's showing you the different brackets so zero to ten thousand and change is ten percent ten two seventy five to this amount is 12 percent and so forth and so on okay so that's how I was able to develop this and that's what you should do too maybe go to this calculator uh plug in if you're single or married filing jointly type in what the um amount of profit is that you had from your business put in if you have a child or not and it will calculate the tax credits like if I had put in one uh dependent then all of a sudden I owe about two thousand dollars less because the tax credit is two thousand dollars you see this number went from ten thousand three seventy four to eight thousand three seventy four so I'm gonna switch that back okay um also too while doing this you might want to add your spouse's income here too so again I'll explain why this is 80 and not 100 in a second but let's say your spouse makes a hundred grand as an employee okay so now you got a hundred and eighty thousand dollars okay this is how you might estimate how much tax you owe so you might now owe close to thirty four thousand dollars in federal income tax so what you might want to do is say okay well we're gonna owe forty thirty four thousand dollars in federal income tax let me subtract the amount of taxes being withheld from my spouse's paycheck each time she gets paid right so let's say for the entire year she's having um I don't know thirteen thousand nine hundred and twenty eight dollars withheld from her check that leads you to believe okay well now I need to make sure I pay at least 20 grand into the system to make sure that when I pay my taxes at the end of the year I don't owe a bunch that might have gone um that might have been a little bit um too detailed here so let me switch this just back to single and um income of of 80 grand okay so again single 80 grand ten thousand three uh ten thousand three seventy four is how we got to this number right here for state income tax you might want to use a tool I have something pulled up for that as well right here this is by the tax Foundation I'll put this link in the description below too it just goes through each state I decided to just pick uh Alabama as if that was the state that I was having and I said hey um the state tax bracket you know as soon as you hit 6 000 in income uh married filing jointly or 3 000 in income as a single file filer you're paying five percent so what I did for Simplicity purposes is just said hey um I'm just going to do five percent for this math right so I took the 100 Grand multiplied by five percent same thing here 100 Grand by five percent here it's the 50 Grand uh times five percent okay so that's how I kind of estimated that number but go to um you know this website if you don't know how much your tax your State uh you know the tax brackets in your state or if you're in a state like Alaska there's no income tax right so you don't have to worry about that part of it so maybe use this website as a reference to um calculate your numbers okay so I think it's time that I sort of addressed this thing that I mentioned a few times now let me read this box to you it says no remember this is all just an estimate okay for the sole prop and partnership examples you can use 14 instead of 15.3 to account for a federal tax deduction you receive for paying self-employment taxes so what I mean by that is earlier I was saying hey 100 Grand times 15.3 percent is fifteen thousand three hundred if you really want to dial that in and you're doing this math over for your own business take the 100 Grand multiply it by something more like 14 because that's probably what the number is going to be like because you get a little bit of a tax deduction for paying self-employment taxes um so if you want to dial it in that's what the number you can use let's look at the other sentence here so also for the sole proprietorship and partnership examples you can reduce the business profit which was 100K in my examples right 100K and 100K over here by about 20 percent when calculating the federal income tax to account for the qualified business income deduction I know I'm giving you a lot of information here but basically uh there's a deduction that applies to Sole proprietorships and Partnerships to where um you get a 20 deduction based on your business's profit that's why when I was showing you you know the income tax calculator here instead of a hundred grand I put in eighty thousand dollars right because I kind of was trying to get you a truer number to account for that if I didn't if I just left a hundred grand here you can see that instead of um ten thousand and change in taxes it's now now almost like 15 grand so that uh qualified business income deduction is pretty powerful all right um let's let's go on and read what it says here for the S corporation example you can reduce the distribution amount which is here the sixty thousand dollars um by about 20 percent when calculating the federal income tax to account for the qualified business income deduction all right so for the S Corp example I entered 88 000 because I took twenty percent off of the sixty thousand okay so that was forty eight thousand plus the 40 000 of reasonable compensation to arrive at 88 000. let me show that you to you visually just in case that kind of misses you up eighty eight thousand dollars is what I put here um where did that come from again that's the 40 Grand here and then I reduce this amount by 20 so I took forty eight thousand uh plus the 40 and that's how I got to uh eighty eight thousand dollars okay again for the partnership example I entered in forty thousand dollars for each partner because I took twenty percent off of the fifty thousand dollar profit number to arrive at forty thousand dollars okay I'll just show it to you visually just in case I'm all I'm saying here is instead of fifty thousand dollars of profit I put in 40 Grand to help account for that qualified business income deduction to show me the taxes that I might oh again your numbers might be different and they should be different right if you're married switch the filing stylist to married if your spouse makes income as well then throw her income in here his or her income in here too so you get a more uh realistic number for your exact situation okay so what I would recommend actually is follow my steps go through this video again watch what I did and then do this for your own business so you can have a better idea as to how much tax you're going to have to pay if that last part confused you about reducing stuff for twenty percent and stuff like that you know that was all related to the qualified business income deduction skip it okay just skip it just know that your estimate will be a high estimate and if you make those payments throughout the year you're going to end up with a tax refund so that could be like a bonus that you didn't realize was coming your way okay as I mentioned earlier I'm just touching really on the surface here about some of these things um you know if you're a little confused that's totally okay and normal if it's the first time you're seeing some of this stuff you may need to watch again that that part of the video one more time but in my course I have more time with you and I make sure you understand all these pieces of the puzzle and and you know just kind of make it easier for you obviously I'm just teaching you on this topic today right but I'm also teaching you in the course Tax Strategies like how we make the S corporation strategy even uh better by incorporating health insurance premiums and health savings accounts how to deduct your home office cell phone internet hire your mind your children establish retirement accounts as a business owner you can contribute over sixty thousand dollars in a Roth account that's after tax money um for your retirement when you're a business owner okay so give that a look if you want to learn how all of this stuff works you can go to my website again click this video it'll talk you through it for about four minutes or so so explain it to you and you can preview all this content here that you see the courses pretty comprehensive okay we color a lot of things here nothing too much to where it gets boring and monotonous but just enough to learn all the strategies and how to properly Implement them so you might be asking you know when all your taxes due as a business owner well really this applies to even if you're not a business owner if you think uh you owe money in taxes that can mean that you're even if you have a day job and your day job is not withholding enough tax from your paycheck well then you can go into the IRS system and make tax payments when you would you do that well it's set up in equal quarters q1 April 15th Q2 you can see the dates here June 15th Q3 September 15th and Q4 right September 1st through December 31st it's January 15th obviously of the following year okay so that's when the tax payments are generally due a big question is well okay Navi you told me how much I might owe and how to pay and how when to pay those right but let's talk about now how do you pay the tax that you owe so for federal taxes you could you have a couple options um you can go to irs.gov forward slash payments to use this service here called direct pay all right on the direct pay website that you can see here you can pay your individual federal income taxes and you can also pay self-employment taxes there okay if that's a little bit confusing I always want to make a distinction here um so if your tax is a sole proprietor you can go to the direct pay website and pay these your self-employment taxes and your federal income tax uh payments okay same thing as a partnership you can pay your um self-employment taxes as a partnership and you can also pay your federal income tax there as well well all right so hopefully that kind of clarifies what you can use direct pay for you can also use the EFTPS system that's right here it's eftps.gov maybe I'll throw that in the description too if you're watching on YouTube um and you actually may be required to use this system so this system just so you know requires Advanced registration so it takes about two weeks to set it all up however on this system the EFTPS system in addition to making individual federal income tax and self-employment tax payments you can make business tax payments so on EFTPS you can register as an individual or a business I know that might be a little bit confusing what I mean by using EFTPS for business payments is for any taxes that the business itself is required to pay so for example if you have an S corporation your business is required to pay the employee and the employer portion of Social Security and Medicare taxes and you know you also have to pay the federal income taxes that might have been withheld from the employee's paycheck even if that's your own paycheck okay if you're the only employee of your S corporation so if you're making payments on behalf of the business entity then you need to use EF uh the EFTPS system I'll show you that visually real quick I'm saying if you're an S corporation and you're set up properly fees tax is right here as well as um federal income taxes that might be withheld from your paycheck those are tax payments that the business is actually making okay the business is making them on behalf of the employee in this example John okay so um that's what you really use the EFTPS system I mean as a general statement I'll say this if your tax is a sole proprietorship or a partnership you can make your payments uh via direct pay if your tax is an S corporation the S corporations tax payment should be made via EFTPS okay state taxes this doesn't apply to a lot of you but some of you are in a state that has state income tax right what you'll do there is you can just visit your State's Department of Revenue website and there's usually instructions on how to pay your individual state income taxes okay um I just want to emphasize um in my opinion if your taxes in S corporation my advice is to hire a payroll company to handle all of your payroll reports and all of your tax payments that are required this stuff is kind of a mess to do on your own I don't even like doing it as an accountant okay um what you'll do is when you hire a payroll company it's now their responsibility let them handle that you should be focusing on generating revenue for your business not keeping track of all the due dates and reports you should have an understanding of what is the payroll company is doing just a high level understanding but don't get into the weed so much that you actually you know know how to do it yourself and are doing it yourself that's just wasting a few hours um every couple of weeks on payroll where you can focusing yourself on Revenue generating business activities instead of you know time suck activities that don't help you generate any Revenue to your business that's kind kind of all I have for you but before I wrap up do me a favor leave me a note in the comment section letting me know what you learned what was helpful what else do you want to understand better did I lose you while going over some of this I want to know so I can help you know create better content for you and if you need me to expand on something I will um in a moment here if you're watching on YouTube at least check out some of these other videos that might be helpful to you if you're interested in learning more about the S Corp taxes and kind of how that works a good video to watch is is one entitled how escort taxes work that'll show you what the idea of this what's called pass through entity work and what taxes the S Corp has to pay versus what taxes you pay as the employee okay do me a favor before you leave don't forget to like And subscribe and I'll see you either in the course or in the next video

Channel: Navi Maraj, CPA

Views: 42,876

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Id: D3Y1EEtb1cA

Length: 28min 6sec (1686 seconds)

Published: Thu Feb 02 2023