When to Switch from an LLC to an S-Corporation

most all business owners are llc's or sole proprietors and sometimes business owners come into the office trying to figure out well should i stay as an llc should i switch to an s corporation when does it make sense to switch to an s corporation [Music] my name is carlton dennis welcome back to taxes made simple and in this segment today we're going to be talking about how escorps can save you money on taxes but before we go into that it reminds me of a story that i have to share with you guys this past december i was up late nights filling out late s elections for a lot of clients who qualified to still have late s elections and part of the reason why i was doing this was to help those clients avoid self-employment tax so the first thing that we're going to go over is lesson number one what is self-employment tax so in order to understand how escorts can save us money on taxes we have to understand what self-employment tax is in order to understand self-employment tax we have to look at who is subject to self-employment tax any person who is a business owner who is a 1099 contractor is self-employed which means that no taxes are being withheld from the wages you receive the compensation you're getting or the commission checks you're receiving so what this means is is that your income is going to need to be subject to federal taxes by the irs state taxes if you're in a state that taxes but social security and medicare tax as well now the government views you as an employee but they also inview you as an employer of your own business did you guys know that social security is 6.2 and medicare tax is 1.45 that equals 7.65 so if you're being taxed by self-employment tax you're going to pay the employer side 7.65 but you're also going to have to pay the employee side 7.65 this is what makes up self-employment tax which is roughly 15.3 percent now i want to reiterate if you have an s corporation you are not paying self-employment tax we will go into what payroll tax is but if you're a sole proprietor or you're an llc earner and you make 1099 income you are paying into self-employment tax on all earned income you receive so if you have income and expenses your net income that's left over is the amount that you're taxed on this is the amount that's subject to federal taxes state taxes and this 15.3 percent of self-employment tax so in order to understand more about how the escort can save us on taxes we need to learn about payroll lesson number two what is payroll inside of an s corporation in order to understand how escort owners save on taxes we first must understand payroll escort owners save on taxes by becoming w-2 employees underneath their own business that's correct they are taxing themselves as a w-2 employee and this is different than when you're a sole proprietorship or when you're an llc when you're a sole proprietorship and when you're an llc you are only just a shareholder underneath your business so what that means is as money comes into your bank account and as you pay yourself out whether it's in the form of a check or just pulling money out of your bank account that is not considered payroll and your business does not receive a deduction the government calls this a distribution now for business owners who are operating as an s corporation the difference lies here when you get to the end of the year as an s corp owner one of the rules that the s corp owner has to do is that the s corp owner has to pay payroll taxes and take a reasonable compensation so what this means is is that the s corporation is going to become an employee underneath the business that's correct when you become an employee underneath the business the irs no longer views you as just the shareholder and this is where the self-employment tax gets eliminated one thing that we have to understand about payroll taxes is that we are paying taxes based on the amount of money we have decided to pay ourselves now one thing to keep in mind with taking payroll as an escort owner you are still paying taxes you're going to pay taxes on business income that you chose not to pay yourself but you are going to pay payroll taxes on the amount of w2 income that you chose to pay yourself i would like to go for an example with you guys let's say that we made a hundred thousand dollars net income inside of our business and we decided to place ourselves on payroll for thirty thousand dollars our business is going to receive a 30 000 deduction because we the owner decided to place ourselves as a w-2 employee underneath our own business now that the s corporation has 70 000 in net income the s corporation is still going to pay taxes on that seventy thousand dollars you the taxpayer that paid yourself the thirty thousand dollars in w2 ages will pay payroll taxes on those w2 wages so you might be telling yourself wait a minute if i'm an s corporation i'm still subject to taxes i have to pay payroll taxes i have to pay federal taxes and i have to pay state taxes so when does it make sense for me to switch from a sole proprietorship or an llc to an s corporation well i have some news for you guys as accountants we look to answer this question for our clients all the time depending on your state there is a certain threshold to where the benefits outweigh the cost from switching from a sole proprietorship or an llc into an s corporation let's go over some of those costs that are incurred when you're switching from a sole proprietorship to a corporation one of the biggest costs to switching from a sole proprietorship or an llc to a corporation is your franchise tax that you pay to the state as well as your tax preparation fees on average tax preparation for a corporation is going to be anywhere between a thousand to two thousand dollars and in most states you're paying anywhere between two hundred to eight hundred dollars just to have your business active every single year and s corporation owners have to take payroll that can range anywhere between five hundred to a thousand dollars a year all in you are going to be at around 3 000 to 3 500 on a yearly basis to have your s corporation so we want to know when does the benefits outweigh the cost to switch from an llc to an s corp in our office we've come to know that it makes sense when your business has netted income in excess of 40 000 as soon as you are over the threshold this is when the benefits outweigh the cost to switch out of your llc or your sole proprietorship to an s corporation if you have earned income right now we are talking to business owners who are making earned income if you own rental real estate this is not the topic for this discussion we will discuss escorts in real estate in a later topic but right now i wanted you guys to have that answer on whether or not you should be thinking about switching from the sole proprietorship or llc over into a corporation the next thing we need to understand in order to know why s corp save so much money on taxes is this whole topic around reasonable compensation so we talked about how s corporations have to take payroll but they have to take payroll in a reasonable amount so what is deemed a reasonable amount to the irs and what is deemed a reasonable amount to taxpayers determining a reasonable compensation is the most murkiest part of s-corps the reason why is because the government bases reasonable compensation based on your industry and your geographical location let me give you an example let's say that i'm an engineer in southern california and geographically located in los angeles there are engineers that are making the medium salary of 60 000 every single year that means that engineers in this area of los angeles have a medium price point of getting sixty thousand dollars in compensation a year in the irs that would be a reasonable compensation for an engineer but let's just say my business only made seventy thousand dollars and i only had net income after all expenses of fifty thousand dollars it wouldn't make sense to put myself on payroll for sixty thousand dollars would it no and i don't even have enough income in my business to justify taking payroll of sixty thousand so this is when we have to start breaking down this reasonable compensation term we have to look at it more closely and under fine lens what is your industry and what are you doing and where are you located and next what is your net income rule of thumb in our office is we don't allow business owners to take a reasonable compensation on less than thirty percent of net income which means that if you made a hundred thousand dollars at minimum you need to take thirty thousand dollars in payroll and reasonable compensation yes your business will receive a deduction when you do take this reasonable compensation but is still something we need to take now i want to transition into is reasonable compensation saving me more money than paying self-employment tax by being a sole proprietorship in an llc this is where you see the difference lie when you take reasonable compensation you're taking a far reduced amount of money on payroll that shows up on the tax return going back to that example that we just gave you if we made a hundred thousand dollars in our business and we took thirty thousand dollars in payroll on the tax return it's only showing up as thirty thousand dollars in w2 wages that's subject to federal taxes and state taxes thirty thousand dollars is a single file that puts you into the twelve percent tax bracket you're gonna pay about thirty six hundred dollars on that we're okay with that if you're in the state of california that's about another eight and a half percent then you have your other 70 grand that was left in the business that's gonna flow over to you that you're going to pay taxes on now one thing you have to understand about flow through entities such as a sole proprietorship an llc and an s corporation those are our flow through entities is flow through entities receive a 20 qualified business income deduction now that 20 qualified business income deduction is on net income and there are certain thresholds so when you're thinking about you know does it make sense for me to take a huge payroll you first need to look about how much money is going to be subject to that 20 qbi deduction let's go back to our example if we had 70 000 left over net income in our business 20 of 70 000 guys we can do simple math that's 14 grand that we do not have to pay taxes on that's our deduction now we have 56 000 in taxable income that flows over into our individual taxes you guys have heard the term flow through entity what that means is is that the s corporation does not pay taxes the shareholder you and i we pay taxes at the individual level so when that money that we didn't pay ourselves flows over to our tax returns that's where is subject to just federal and state taxes no self-employment tax this is part of the reason why s corporations are so powerful and why we recommend switching to an s corporation if you are making earned income in excess of 40 grand but of course it is always important to speak to your tax provider because every single person has different goals in different visions you may have a vision to eventually get a business evaluation and to sell your business which may mean needing to have a c corporation and not even looking down the avenue of an escort so i urge you to do tax planning like most escort owners do meet with a tax strategist to figure out which strategies make the best sense for you to leverage now and to leverage later my name is carlton dennis and i look forward to seeing you on the next video and if you liked this video i would love for you to like comment subscribe and i'll see you in the next one

Channel: Karlton Dennis

Views: 466,754

Keywords: LLC vs. S-Corp, When to switch from an LLC to Scorp, When to setup an LLC vs S-Corp, Scorp or LLC, llc or scorp, When to switch my LLC to an S-Corp, Scorp benefits, S-Corp payroll, When to use an S-Corp vs. LLC, How to switch my LLC to an Scorp, How to use an Scorp for tax savings, Scorp tax savings, S-Corp vs. LLC tax benefits

Id: -TTZhQ3BWwk

Length: 12min 22sec (742 seconds)

Published: Fri Jan 29 2021