When Does an S Corporation Make Financial Sense? | Sole Proprietorship vs. S Corporation

When should your business be taxed as an  s-corporation that's going to be the topic   of this video and specifically when does it make  financial sense for your business to be taxed as   an s-corporation so um i'm going to be talking  about how the s corporation saves you money   the cost associated with having an s corporation  and sort of what is the break-even point how much   profit do you need for it to make sense to be  taxed as an s-corporation this is your first   time watching my name is Navi Maraj i'm a cpa  that specifically works with realtors around   the country save thousands of dollars in taxes  but if you're not a real estate professional   please do continue to watch because this strategy  really applies to all small businesses um so let   me just lay the foundation here um i on my youtube  channel you'll find a video that i shot recently   where i said hey there are four reasons where i  believe you should not have your business taxed   as an s corporation um and that's right you heard  me say four reasons why not to okay um everyone is   talking about why you should be an escort but i'm  telling you there are reasons why you shouldn't be   some of those reasons are and you know the topic  of this video is um you know you're not making   enough profit for it to make financial sense and  we're going to take a deep dive into that in this   video but the other reasons were if you might have  w2 income so you are employed somewhere you make   a high salary but you also have a business on the  side it may not make sense for your business to be   taxed as an s corporation another reason might be  your state does not recognize the s corporation or   taxes it very heavily and so you don't see any  real tax savings there um and the fourth reason   was you pretty much do passive activities in  the eyes of the irs an example of that would be   investing in buy and hold rental real estate  where you are the landlord and you have a tenant   and you just make passive income which is that  rental income in that situation you would not   want to be taxed as an s corporation so this  again this video is going to be taking a deeper   dive into sort of reason number one which was  um you know you may not be profitable enough   and it may not make sense so let me sort of  transition to the whiteboard here and we'll   dive into this okay so i'm saying here that if  your business is taxed as a sole proprietorship   or maybe it's a single member llc which is  taxed as a sole proprietorship i know that   already might be a little bit confusing i've  got videos on my youtube channel that talk about   you know when to form an llc corporation all that  different stuff so watch that video that'll make   more sense so i'm saying here your tax is  a sole proprietorship so you had a revenue   of sixty thousand dollars yet expenses of twenty  thousand dollars which left you with a profit of   forty thousand dollars right some of you might  be saying wow 20 000 expenses that's kind of high   considering you only made 60 000 in sales  well you know when you work with an accountant   who knows about different tax strategies  they're going to show you strategies that   sort of increase your expenses and so that's why  i kind of put twenty thousand dollars in expenses   there so your profit is forty thousand dollars  so what taxes do you have to pay as a small   business owner you know making forty thousand  dollars a profit well you pay two types of taxes   those taxes are self-employment taxes so you'll  pay fifteen point three percent of the profit in   self-employment taxes so that equates to about six  thousand dollars and you'll have federal income   tax that you'll have to pay on the forty thousand  dollars so i don't know where you're gonna fall   within the tax brackets zero percent is probably  not realistic but you're probably falling between   ten and as upwards of forty 40 um depending on  what you know if you have state income tax or not   so again you pay two types of tax on your profit  self-employment tax federal and state income tax   but what happens when you're an s corporation  right what is this strategy all about well   this strategy is all about self-employment tax  so what i'm trying to drive home here is that   it has nothing to do with income tax okay this  all has to do with self-employment tax you're   going to pay the income tax at about the same rate  when you're an s-corporation but what changes is   the self-employment tax so specifically you know  you still have forty thousand dollars in profit   when you're in s-corp right you didn't sell  any more product or offer any more services   when you're in s corp but what happens is this  forty thousand dollars in profit is split into two   buckets right so i call i put w2 here what i mean  by that is the irs wants you to take a reasonable   salary when you're an s-corporation so here  i'm saying on forty thousand dollars of profit   that reasonable salary might be about half  it might be like fifty percent of this so   you'll take a salary of twenty thousand dollars  and that salary will pay self-employment tax um   so 20 000 times the 15.3 percent you're gonna  get self-employment tax of about three thousand   dollars right now what happens to the other half  you know the second bucket well that second bucket   you're going to take as a distribution from your  s corporation and so how much self-employment tax   do you pay on the distribution and the answer  is zero so you don't pay any self-employment   tax on distribution on the distribution so in this  example as an s corporation you pay three thousand   dollars in self-employment taxes whereas here you  paid um six thousand dollars in self-employment   taxes so you have a savings of three thousand  dollars right the six thousand here versus the   three thousand there gives you a three thousand  dollar uh tax savings again federal income tax   you're gonna pay that here and you're gonna pay  that as an s corp so that really doesn't matter   so what are the costs associated with having an  s corporation so you're going to have a few you   might have a couple more than these but these are  the big ones so you're going to have to either   form an llc or create a corporation and then  elect to have it taxed as an s corporation and so   when you form that llc or corporation you are  going to have to file an annual report with   your state each year and the fees on that  depend or change i should say from state to   state right so this could be as cheap as 100 it  could be as much as 300 so i'm just saying 150   another fee that you'll have is tax prep fees so  you know if you're dealing with a competent cpa   or accounting professional who is taking the time  to teach you strategies implement those strategies   they're probably going to charge you anywhere from  800 to 1200 okay so i'm saying you know your tax   prep costs might be about a thousand dollars  if you're working with you know a not so good   accountant who's just gonna take the numbers that  you give them and throw it in their tax software   then maybe you can get away with paying less  but again you get what you pay for you might   end up paying more in taxes if that's the type  of professional that you decide to work with   other costs you have are payroll i believe i  said earlier that with an s corporation you   have to take a quote-unquote reasonable salary  per the irs trust me you probably don't want   to be dealing with the paperwork associated with  having payroll because you have to make either um   or not either but both quarterly and annual tax  reporting requirements and so you really don't   want to deal with that you want to be focused on  running your business and growing revenue and so   you'll hire a payroll processing company to do  that so that might cost about 50 bucks a month or   600 for the year so when you add up all these  costs you get about 1 750 right so from here i'm   saying this is kind of like the break-even point  where i think it makes sense to maybe have your   llc taxed as an s-corporation because you know you  would have been paying 6 000 in self-employment   self-employment taxes here now you only have to  pay three so you save three thousand dollars in   taxes but then you have these costs right so when  you take the three thousand dollars of tax savings   and you deduct the seventeen hundred fifty dollars  in additional costs you're really pocketing about   1250 dollars in your pocket right so you don't  want to deploy this strategy to break even   you want to deploy this strategy when you can at  least make you know 1200 and put that back in your   profit but what about when you start making more  money than this right what about if your profit   is more like sixty thousand well and then in that  example you might tweak some of these numbers you   might tweak how much you get paid in the form  of a salary versus a distribution and so you   might save more like fifty five hundred dollars  in self-employment taxes or if your profit is   seventy five thousand dollars then you might save  more like sixty five hundred and if your profits   you know a hundred thousand dollars or more  then you can easily save ten thousand dollars   in taxes sort of by deploying uh this strategy  right um so i hope that you found this video to   be informative and you receive some value out of  it maybe i cleared some things up for you that   are not so clear when you watch other videos  or you're trying to research this on your own   as i mentioned earlier i'll be producing other  videos on those other three reasons where i   said it may not be a good idea to be taxed as  an s corporation so you can learn the reason   why i'm saying these things and apply it to your  small business so make sure you subscribe so you   can catch that content as i release those videos  if you'd like to contact me and you're watching   this on face sorry on youtube rather you'll  see the information below in the description   or if you're on other you know social media  platforms and you're watching this video   just visit my website which is navimarajcpa.com  or you know click on my profile within that   social media site and i'm sure there's a  link in there to take you to my website   or maybe my scheduling page to um spend some  time with me so i appreciate all the comments   all the feedback i've been getting like i said  do subscribe and i will see you in the next video

Channel: Navi Maraj, CPA

Views: 9,471

Keywords: LLC, Sole Proprietor, Sole Proprietorship, Corporation, S Corp, S Corporation, C Corporation, Tax Difference, Single Member LLC, Multi Member LLC, What is the difference between an LLC and S Corp, What is the difference between an LLC and S Corporation, PLLC, What is a LLC, What is a Limited Liability Company, What is a S Corp, What is an S Corp, LLC vs Corp, Sole Prop vs LLC, Start a business, How is a LLC tax, Legal difference between LLC and Corporation

Id: QFYFGfHOuwI

Length: 10min 4sec (604 seconds)

Published: Fri Dec 11 2020