When NOT to have your LLC taxed as an S Corp | Sole Proprietor vs. S Corporation

In this video i'm going to discuss four scenarios  in which you do not want your business to be taxed   as an s-corporation that's right you heard me  right i said not be taxed as an s-corporation   there's so many videos out there promoting the  s-corporation and why it's so great and it is it   can save you a lot of money in self-employment  taxes but you must also know what the drawbacks   are it doesn't fit every single business owner out  there so i'm going to touch on the following four   scenarios one is how much profit should you  be earning in your business before it makes   financial sense to have your business taxed as an  s corporation the second one would be how large   amounts of w income sorry w-2 income rather can  negate the tax savings of an s-corporation so by   w-2 income i mean you are employed by an employer  and actually like have a job that you earn money   at what happens when your state that you live in  does not recognize the s corporation or perhaps   they tax the s corporation and lastly why passive  income such as buy and hold rental real estate   should not be taxed as an s corporation so if this  is your first time watching my name is Navi Maraj   i'm a cpa who helps real estate professionals  that's real estate agents and realtors and brokers   across the country save thousands of dollars  in taxes but um that said if you are a regular   business owner and you don't deal with real estate  stick around because this bus this video is going   to apply to all small businesses um let me just  lay that lay the foundation for you a moment   uh we're talking about when the s corporation  may not make financial sense right and so   before watching this video some of you may want  to brush up on the different differences between   what a sole proprietor is an llc an s corp and a c  corporation and i have another video on that topic   so if you're not quite understanding what i mean  by an s corp or how an llc is taxed as an s corp   or a corporation a c corporation that is can  be taxed as an s corporation you might want to   watch those videos first and i'll link them  either in the description or somewhere else   depending on where you're watching this video as a  refresher though from some of those videos and me   diving deeper into the s corporation remember  that the profit from your business is subject   to two different types of tax right so the profit  from your business is subject to self-employment   taxes and it's subject to income taxes both  both at the federal and state level okay   self-employment taxes are another way of  saying social security and medicare taxes okay   the s corp strategy is all about saving money in  self-employment taxes it doesn't have anything to   do really with the federal income tax or the state  income tax so whenever you hear s-corp understand   that it's a strategy related to saving money in  self-employment taxes and not so much federal   income taxes or state income taxes recall that  self-employment taxes are paid at a rate of 15.3   percent on the profit of your business so let's  say you have a very profitable business that has a   hundred thousand dollars in profit you're gonna  pay self-employment taxes of fifteen thousand   three hundred dollars if you're taxed as a sole  proprietor and not taxed as an s corporation   okay so now that you have that knowledge or that  foundation let's talk about the reasons why you   should not be taxed as an s corporation so i'm  just going to hit the highlights here in this   video uh my plan is to create subsequent videos  that dive into these topics in greater detail   so be sure to subscribe so you don't miss those  videos because i think understanding the why is   just as important of understanding these  sort of statements that i'm making so   how much profit should you be earning in your  business before baking uh the s corp election   and in my view sort of the general is  40 000 and i'm defining profit here as   revenue minus your expenses right so some  of you earn your revenue by selling products   others of you earn revenue by selling services  right so either way i'm defining as profit as   the income that you earn the revenue that you  earn minus all your tax deductible expenses so um   the reason for the forty thousand  dollar figure and why i think that's   sort of the um generic amount of profit you should  make before making the s corp election is because   of the additional cost associated with an s  corporation so you're going to have uh tax   preparation fees because the s corporation is a  separate tax return than that of an individual   uh that's taxed as a sole proprietorship let me  say that one more time or a little bit differently   when you have an s corp you have to fill out or  file a s-corporation tax return which is different   than when you were perhaps an llc tax as a sole  proprietor or perhaps you didn't form an llc and   you're just tacked to the sole proprietor  there's now two separate tax documents that   need to be filed and so cpa is going to charge  you money to do that for you right also when   you're in s corp you're going to need to take  a quote-unquote reasonable salary per the irs   there's a lot of paperwork that has to deal  with paying yourself and so you'll likely   hire a payroll service to perform that for you  and also there's the annual maintenance of an s   corporation or perhaps the annual reporting of  an llc that's taxed as an s corporation or the   annual reporting of a c corporation that's  then taxed as an s corporation all of these   are fees involved in having an s corp right and so  basically you know it's cost benefit analysis so   you want to make sure that these fees don't  outweigh your tax savings and i have found   that it's usually around the 40 000 mark where  it makes sense to make that s corp election but   you know it's not a one-size-fits-all answer and  you should consult with your cpa or perhaps myself   to make sure that it's right for you the  second reason why you may not want to be   taxed as an s-corporation is when you have  high w-2 wages so if you are an employee   at a company and also have um a small business  right so you you work state of nine to five and   you also have a side hustle where you might sell  on amazon or you sell real estate on the side   if your rate if your wages already exceed  what's called the wage base which in 2020   is currently 137 700 that means your income has  already hit the cap for social security taxes so   the s corp strategy is not going to save you any  money as a matter of fact you'll actually lose   money if you elect the s corporation status for  that business because your s corp will pay for the   employer portion of social security and medicare  taxes unnecessarily because if you're taxed   as a sole proprietor you wouldn't have any of  those additional payroll costs associated with the   s corp and i i get it that you may not understand  the details of what i'm saying here the important   thing to note is that if your salary is a you know  137 000 at your day job or higher and you're also   have a side hustle you might not want to be an s  corp okay um again the details will be discussed   in another video um there's still an opportunity  for the s corp to make sense when your base wages   are that high but instead of a 40 000 profit  your s corporation profit may need to exceed   two hundred and fifty thousand dollars so you'd be  having a very profitable business on the side in   order for the s corp to make sense all right the  third reason is related to your state's uh tax   laws so some states do not recognize the federal  escort election or if they do um the state uh   taxes the profits of the s corporation so um some  states that come to minor or cities i should say   new york city uh tennessee uh and new  hampshire those kind of off the top of my head   uh don't assume that that's an exhaustive list  there might be a couple others that i'm just kind   of forgetting about at the moment but um what  happens in these states is they um they may tax   the revenue that you earn so not the profit they  actually might tax the revenue that you earn or um   they may tax the profit of your s corporation  at a pretty high tax rate and what happens is   uh they tax not just the profit but they also  tax the distributions when you as the s corp   owner uh take a distribution from the profit  of the s corp and as a result a lot of the s   corp tax savings are eaten up by these additional  taxes and the strategy just no longer makes sense   again another video i'll go into the details um  if you're in a state i just mentioned you might   want to consult with a cpa in that state or that  has knowledge about that state or that city's   tax laws to make sure you're getting the right  advice okay not all cpas and tax preparers   take the time to understand all of this so you  might have some tax payer preparers are just   like yeah you know everyone's an s corp you should  be in s corp too without even asking some of these   questions that they should be asking the fourth  and final reason and you know there's probably a   couple other reasons but these are the big ones  is passive income okay the irs classifies your   income as either active income or passive so what  do i mean by these things basically if you run an   operational business so let's say you're a realtor  or you're a physician or uh you run an e-commerce   store you are heavily involved in the day-to-day  to generate that revenue and as a result the   income you earn is considered active uh by the  irs which means that you'll pay self-employment   taxes and income taxes on your profits but when  you're involved in passive activities such as buy   and hold rental real estate right where you're the  landlord and you have a tenant paying you rental   income that passive activity profit is not subject  to self-employment taxes still subject to income   taxes but not self-employment taxes but for some  reason you know i can't really figure it out some   people have rental real estate in s-corporations  and as a result they are subjecting themselves to   self-employment taxes for no reason they shouldn't  be paying those to begin with right um so   i hear so many youtubers using the term passive  income incorrectly right and they're sort of   referring it to it as like hey you know once  up you once you set up this you know amazon   store or what have you and it's drop shipping and  they're ordering direct from the company yeah it's   sort of passive in the sense that like you're not  really doing a lot of work to earn that income but   it's that term is used incorrectly in the in the  eyes of the irs and from a tax perspective okay make sure you use the term properly um when you're  talking about taxes especially when you talk to an   accountant or tax preparer um so again selling  on amazon via fba is not a passive activity   so i hope this helps i hope uh it at least  educates you on some of the scenarios where   you don't want to be taxed as an s corporation as  i mentioned earlier i'll be producing some videos   on sort of the why behind these four scenarios to  help you better understand this but make sure you   do subscribe so you can catch those as they are  released and you'll have a better understanding   of how all this works if you'd like to contact  me and you're watching on in youtube all of my   info is in the description below or you can visit  my website which is navimarajcpa.com if you're   watching on some other platform i'm sure if you  click on the link and visit my profile you'll find   my website there as always i appreciate all  the comments all the feedbacks many of you   are sort of reaching out to me and putting time  on my calendar and we're having great discussions   and i appreciate it like i said do subscribe  and i'll see you in the upcoming video

Channel: Navi Maraj, CPA

Views: 45,989

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: EE3Oe1H2iyE

Length: 12min 48sec (768 seconds)

Published: Mon Nov 16 2020