Transcript

Steven Jarvis:

Hello everyone and welcome to the next episode of the Retirement Tax Services podcast, Financial Professionals edition. I am your host, Steven Jarvis CPA, and in this show, I teach financial advisors how to deliver massive value to their clients through tax planning. I’m really excited today, we’re going to focus on tax planning for small businesses, and my guest happens to specialize in this – I have with me on the show Mike Jesowshek, who is a CPA and the host of the Small Business Tax Savings podcasts. So Mike, welcome to the show!

Mike Jesowshek:

Yeah, pleasure to be here and thanks for having me on the show Steven!

SJ:

Yeah, of course! Now, as we were getting ready for the show and talking about some of the things we’re going to discuss today…[I’m] really excited because we hit on several things that are just great for small business owners, and of course I was a little bit excited to see a topic I’ve shared before, just to get to that reinforcement that I’m not the only CPA out there talking about them. But really what we want to do is talk about the top five tax strategies for small business owners in 2021 so that we can – whether it’s advisors listening for their own businesses or as they have clients who have small businesses, just look at some of these tax planning strategies that we can use to make sure that ourselves and our clients aren’t overpaying the IRS. That’s what we try to focus on here. So Mike, why don’t you go ahead and kick us off?

Strategy 1: Maximizing Tax Deduction [01:48]

MJ:

Yeah, thanks for having me again. One thing that we talk about…in one of the first strategies when we’re looking at tax strategies, especially in 2021 and really any year – is this idea of maximizing deduction. And so many times when I introduced this as a tax strategy everyone’s just like, “oh yeah, so I’m just going to go out, buy a new truck, buy a new computer, spend all this money that I don’t need to spend.” And I’m like, “no, that’s not what we’re talking about.” Now, of course, if you need a new truck or if you need a new computer and things like this and they are business related, let’s make sure we’re purchasing those. But when we talk about maximizing the deductions, we’re talking about finding ways or spending that we’re already doing and seeing if we can find a business purpose for it and get a business deduction for it. When we look at maximizing deductions, we look at these, kind of, two different areas. We look at pre-tax dollars and after tax dollars, and our thought is how can we turn after tax dollars into pre-tax dollars? So most people do all their spending, you know, if you’re a W2 earner, any spending you do is considered after tax dollars. So you get your paycheck, which is gross, you have all these taxes taken out and whatever’s left over – that is after tax money that’s already been taxed, and any spending you do on that is on after-tax dollars. You know, a good example of this is when COVID hit, and we had some professionals that are W2 employees, who have to go home and work at their home office. Now they have a home office, they’ve maybe had to buy a desk ,they’re using their internet and stuff like that, that’s all from the home, and because they’re a W2 employee, they’re not getting any deduction for that. They’re not able to get a deduction for those items that they’re picking up, but let’s flip the switch and let’s look at a business owner. With a business owner, we have our sales or income or our revenue, and we have all these expenses that go into the business and then whatever’s left over is what we ultimately get taxed on. So when we look at a business owner, we have the ability that, if we’re a business owner that was working in an office and now we’re getting put into our home, we can buy that desk. That’s a business deduction. We can take a portion of our internet, we can take a portion of our rent or mortgage interest, we can take some of these items and claim them as a business deduction. And so when we talk about maximizing deductions, we’re saying, you’re going to pay for the internet for your house either way, you’re going to pay for a cell phone for yourself either way, but how can we take that spending that you’re already doing instead of using it after tax, not getting any tax dollars for it, how can we get creative and how can we get a business deduction for at least a portion of that spending? So that’s what we’re talking about when we’re talking about maximizing deductions. And honestly, I think this is one of the most overlooked areas, that small business owners avoid or don’t think about, and there’s different ways that I can tell people to do this, I always say, track everything, go through your personal account and let’s start looking down the line, what are some of those things that you might’ve done spending on that have a business purpose that you just happened to run through personally? How can we maybe change that as we look forward? So that’s things like travel, home office, automobile, dining with others, things like that. So I always say get creative and strategize, and kind of look at that spending and say, is there a way that I can turn some after tax dollars, money that I’m gonna be spending anyways into pre tax dollars? Some of the other strategies that we’re going to talk about today are exactly part of that. You know, one of them we talk about is hiring our kids, and you know, we pay for basketball camps and we do all these other things for our kids, typically after our money’s already been taxed, but if we hire our kids in our business, is there a way that they can then pay for those camps? Now we’re getting a business deduction to send our child to a basketball camp or something like that. So that’s kind of the idea behind this whole maximizing deductions – t’s not spending money on things that you don’t need, it is taking that spending that you’re already doing and how can we repurpose it, find a business purpose for it and now get a business deduction for it instead of it being an after tax spending.

SJ:

Yeah, I love that that’s where you started because I mean tax deduction is certainly a term that everyone’s heard of and so it can make it feel like, “oh, wait, we’ve got this, this is the easy one,” but a lot of times where we can make the most ground on whether it’s maximizing deductions or just this general idea of how do we stop overpaying the IRS, it’s consistently applying a successful strategy to the simple areas of having…you mentioned in there, okay, going through your personal account and seeing – are there expenses in here, there’s things I’m already spending money on that have a valid business purpose? Especially when we have things changing in the world, like COVID happened this last year, maybe there are things in the past that didn’t have a valid business purpose but now because of the virtual environment or whatever it is, however our business has shifted, that we have an opportunity to go back and look for those things, and especially as we’re talking to advisors and you know, they’ve got to work with their clients on these things, every little bit of education we can give to a client is just that much more value to them, whether it applies currently or something that they might be able to apply in the future, we can’t take for granted that just because everyone’s heard of a tax deduction, that they really understand what that means. Growing up, my dad was a small business owner, I really thought tax deduction meant free money. That was a long time ago, I am a CPA now, I do know the difference, but I think a lot of people kind of have that misconception of, “oh, if it’s a business deduction, I should just go out and buy things I don’t need” because well…it’s a tax deduction. So yes, I really appreciate that reinforcement, really this needs to be things that we were going to spend money on anyway, so that we can get that tax benefit, but we’re never going to come out ahead spending money just for the tax deduction.

MJ:

Yeah. And that’s exactly right. You don’t know how many small businesses that are listening to our podcast or are coming into our programs that are like – “I don’t know if I can deduct this, I put a sponsorship of my company name on our kids T-ball shirts, is that a business deduction?” And we’re just like, “yeah, of course it is!” You’re doing advertising, and so I think that’s the other idea behind this is that there are so many things that are business deductions that a lot of business owners just don’t know. And then you have the opposite end of the spectrum of somebody trying to write off their house, their whole entire house is a business deduction. So I would never encourage someone to get aggressive or do blatant fraud, like those types of things but it’s just knowing and being aware of, kind of, what those deductions are, and taking advantage of them, and that’s the beauty of being a business owner, is the ability for us to take advantage of the tax law. Um, we’re not abusing the law, the law was written the way it was for a reason, and that reason is because this is meant to be an incentive and to help business owners out, so that we’re not paying taxes on all of our income, without being able to take a tax deduction.

Strategy 2: Meal Expenses & Documentation [08:12]

SJ:

Yeah. Now there are some areas, especially when you talk about deductions that have, kind of, some additional rules, it’s not just as simple as this was for business so I can deduct the whole amount – which gets us to our next one on the list of our top five strategies, which is how we look at meal expense, which is one that the IRS has a couple extra rules on. So why don’t you talk a little bit more about how you approach this with your listeners or your clients?

MJ:

Yeah and this was actually something that was really cool that changed for 2021, this current year, and 2022 next year. You know, back when the Trump tax cuts came through, one thing that they took out of a tax deduction at that point was entertainment expenses. So they basically said “entertainment expenses are completely not deductible.” We used to be able to take someone golfing, go to a baseball game, and you did at least get a 50% deduction for that, generally meals and entertainment was generally a 50% deduction, but the Trump tax cuts basically took that entertainment piece out, and that entertainment piece is still out. But one thing that they changed due to some COVID relief changes is that for 2021 and 2022, food and beverage expenses from restaurants are a hundred percent deductible. So traditionally food is going to be 50% deductible, but for 2021 and 2022, it’s a hundred percent deductible. So the idea behind this is let’s go out, let’s support these restaurants that were closed down for so many months, let’s be able to support them while also encouraging business owners to do it by getting a tax deduction. So this is, again, an area that, you know, obviously 50% deduction, a hundred percent deduction, that’s great that it’s moved up to a hundred percent deduction, again, that’s just for 2021 and 2022; but this is another area where we look at that after tax and pre-tax area – dining with people. So many people don’t understand how much business they do in everyday conversation, and so we oftentimes say, you know, stop looking at or stop thinking every time you go to lunch, it’s with a friend or a family member. Then you start flipping the switch, I might be going to lunch with a client, a potential client, a potential employee or current employee and start thinking about, are we talking about business at this lunch meeting? If so, let’s try to find a way that we can tie this again into a business deduction. So we go to lunch with a friend who happens to be a client of ours, that’s typically going to be an after-tax dollar, you know, we’re going to spend that money on that lunch and, money that’s already been taxed, but if we think about it thoroughly, they’re a client of ours, we’re talking with them and we’re trying to talk about their counts, their businesses a little bit – how can we get a business deduction for that lunch meeting, that we’re going to have no matter what? But because we can find that business purpose for it, now we’re getting a business deduction for it. And then with that COVID relief changes in 2021, 2022, that’s obviously just kind of sweetened that pot a little bit, where instead of now being limited to 50% where we can bump it up to a hundred percent. Again, the entertainment is still not deductible, but the meal portion of entertainment would be deductible. So that’s something to consider if you’re going to…let’s say you rent out a suite for your clients, and then that suite includes tickets to a baseball game, as well as all you can eat and drink in that suite. We want to make sure that we’re getting an itemized receipt from that, that breaks out the ticket costs, the entertainment piece from the food and drink portion, because if we have that separated, now let’s say we pay $10,000 on a suite, but seven of it is for food and beverages. Well, now we can get a deduction for seven, whereas if we just pay that 10 and there’s no itemized separation, that’s all going to be a non-deductible expense. So it’s just something to consider that if you are doing some entertainment and some peace, entertainment’s not deductible, but the meal portion still is, so make sure you’re kind of getting that itemized breakdown for that.

SJ:

Yeah, having an intentional approach for these things, and for 2021 and 2022, we just had that extra incentive of it being 100% deductible. This is also an area that reinforces what a valuable resource you can be in your clients’ lives because there’s endless headlines about tax topics, and your clients are going to get headlines that aren’t even accurate at times, because unfortunately there aren’t a lot of screening mechanisms for who can post things, who can post blogs, who can post social media articles. At one point in the last few months, I saw a LinkedIn post that had a lot of responses and comments and views and all of that – the person who wrote said: “Hey, great news for 2021 and 2022, all of your meals, regardless of whether they have a business purpose, are fully deductible.” It’s like, well, wait, wait, no, no, no, no, I mean, because to your point, Mike, I mean, yeah, we can be more intentional about how we think about the business purpose, but there still has to be a business purpose.

MJ:

Yeah, that’s exactly right. I always say, you know, we want to take advantage of what we can but we also got to know where that line is too, to make sure we’re not crossing that line and, and kind of just destroying everything that we potentially have, simply because we’re trying to get a $20 lunch deduction. So it’s just making sure, and the key part about that is what is that documentation that we have? So, you know, as you kind of mentioned, maybe that LinkedIn post, you know, that’s just completely false information, but some people can even try to fudge the numbers a little bit and try to make up expenses that they have and say they are business, but are not business. I always say, don’t be worried about that, make sure that if it’s business-related, make sure you’re taking a deduction for it, and to help protect yourself and make yourself feel better about it, just make sure you’re writing that documentation – who was at the meeting with you, who had lunch with you, what did you discuss? Just so that you have that, if anyone comes knocking, you have a receipt that you can send them that says here’s what we talked about, here’s what we ate and here’s the proof of it. Just make sure you have that documentation, it’s going to make you feel better about that deduction.

SJ:

Yeah, as you wrap up the meal, as you paid the check, I like to just write the names of who was there and take a picture and then just keep that in your records, so you have that documentation if questions ever come up.

MJ:

That’s excellent.

SJ:

So Mike, you already mentioned it, but I definitely get questions on this at times from advisors and from clients that, okay, well what about hiring my kids, how does that work as a potential opportunity?

Hiring Your Kids [14:05]

MJ:

Yeah, and this is one of my favorite strategies to utilize. Now, this one gets…you have to get a little creative, you have to be willing  to work within the laws that are out there, but the general premise of the hiring your kids strategy is that you can potentially pay your kids up to $12,000 tax-free. So you could pay each of your children $12,000 tax free, potentially up to $12,000 tax free. There’s a few parameters that need to be met and a few things to think about but before we get started into that, I want to think of this idea – how can we move after tax dollars into tax dollars, and we know with children that there is tons of expenses that they come up, whether it’s buying toys, whether it’s taking them on basketball camps, baseball camps, whatever it might be, there’s a ton of costs in having children. So if there’s a way that we can get a business deduction for at least a portion of those costs, it’s money we’re going to spend anyways, that’s money that’s going to be out the door – why not get a business deduction for it, when we’re going to be spending it anyway? But it’s not as easy as just “I’m going to hire my kids, I’m going to pay for all the basketball camps for the business,” or anything like that. There are a little bit more details that we need to go through, and so there’s a few things on ‘how do we make this tax-free?’ Now we can hire anybody and always get a business deduction for it, but how do we make this tax-free on the kid’s side? And there’s a couple of parameters. One, your child has to be under the age of 18. Generally we say they should be above the age of seven as well, before we’re hiring them in any kind of business, but as long as you operate as a sole proprietorship or a single member LLC, with a child that’s under that age of 18, you do not have to withhold Medicare, the FICA, which is federal unemployment, you don’t have to withhold social security taxes. So basically that, and because the standard deduction right now is roughly $12,000, nobody in America pays taxes on their first 12,000, at least on the federal level. So let’s go through a quick example. We pay our child $10,000, we’re operating as a sole proprietorship or a single member, LLC, we pay our child $10,000, of that 10,000, they’re not going to pay taxes on it because it’s under the standard deduction threshold, we don’t have to withhold Medicare, we don’t have to withhold social security, we don’t have to withhold FICA taxes. So we just paid our child $10,000 throughout the year that we got a business deduction for, and they paid no income taxes. Now, when we look at that and that sounds great, but there’s a couple of things – our child has to actually be doing work in our business, we must be paying them a reasonable rate for the type of work that they’re doing, so we can’t hire a child $250 an hour to shred paper but as long as they’re doing a reasonable rate for the type of work they’re doing, making sure that we have a clear documentation of kind of what’s expected of them, the amount of time that they’re putting in, making sure we’re tracking their time – it’s a completely valid deduction. I get so many people, especially solo business owners that say, “you know, there’s nothing really that my ten-year-old child can do in my business, you know, I’m a lawyer, I’m a financial advisor, what is a 10 year old going to do in my business?” And I say, “let’s get a little creative, let’s think a little bit deeper on this,” you know, I would say, “could someone do marketing, could they do marketing posts on a Facebook page?” And they say, “well, I don’t do marketing, I don’t need Facebook posts.” But what if you could get a business deduction for it, is having a Facebook page that you post some posts on, that maybe copy and paste some links across the internet, that your child is doing, is that going to hurt you? And so, you know, another idea is that we send out physical mail, flyers and things like that to potential clients, right? Well they [the children] can be stuffing those envelopes, folding the paper that we’re putting in there. So I just say, you know, get creative. There’s definitely some things…just because you’re a financial advisor, just because you’re an attorney or whatever your profession is, doesn’t mean that that’s what your child has to be doing, there’s plenty of work that they can be doing. Now it might not be the full 12,000, they might only have enough, you know, at the age of eight, that might be only $2,000 that you can get legitimately as a business deduction – but that’s fine, that’s $2000 that would have been after tax dollars, so you’ve now moved them into pre-tax spending. The other big thing here is for printing to W2 at year end, it’s just going to be all zero return because there’s going to be no withholdings or anything on the federal side, but you still need to…it’s still good to submit a W2 for them. This also opens up the idea of maybe doing a Roth IRA and for financial advisors, there’s some excitement there of – where we could pay our child $5,000 a year and do a $2,000 Roth IRA for them, because now they have that income that they can, they can offset that with. So there’s some planning around that. Again, the key thing on this is that if you’re operating as a sole proprietor or a single member LLC, there’s no need to withhold that FICA, that social security, Medicare. If you’re operating as an S-Corporation, which is something we’ll talk about and highly recommended, people, but if you’re operating as an S-Corporation, it’s a little bit different because now you would have to withhold that FICA, you’d have to withhold that social security, Medicare, federal employment, things like that. You’re still getting a deduction for all that, but it’s not as sweet of a situation. And so for those, there’s some work where you can set up a family management company that’s a sole prop or a single member LLC, that you can kind of work to finally get that funds to your child, but that gets a little bit more complicated and things like that, ultimately, I would say, just think of that deduction in general, how do we turn after tax dollars into pretext dollars? This is a great way because we know we’re going to be spending money on our kids. No, I’m not saying you pay your child $2,000, they take that 2000 and go to a basketball camp. I’m not saying that you have to make your children pay for their own basketball camps or buy a toy when they go to the store with you, using their money, but why not get a business deduction for that money? Now they have some they can use for retirement or schooling, whatever it might be, whenever, you know, they might go away, there’s money that can be used for that. So this is one of my favorite strategies to use with all business owners. So if they have children that are, kind of, in that range. Now as your children get older, you can still hire your kids in your business, it’s just some of the law changes as far as that completely full business deduction and no income taxes paid by the child – that’s going to change this as the ages go up.

SJ:

Yeah. Uh, that’s a really great description of the advantages that you can get from there. And you mentioned a couple of times about the documentation that people need to have in place, and I know that every now and then I’ll have someone who gets scared away a little bit by the documentation piece, but it’s really not that big of a lift if you do it up front and if you’re intentional about it, and if you’re still intimidated by that little bit of documentation list, find a resource that you can work with, find someone like Mike who specializes in this kind of stuff to say: “Hey, what templates or resources are available, that I can make this even easier?” But you’ve got to make sure that documentation is in place, in case questions ever did come up, but especially as we’re talking about potential to be able to pay our kids $12,000 a year and being able to start setting up Roth IRAs for them at a young age, that the value is exponentially more than that lift of having to get some in documentation in place.

MJ:

Yeah, for sure. The documentation, like you said, it’s not that bad. You know, we’re talking about an employment agreement, we have to track the hours, maybe we have a job description of, kind of, what the child is doing, but ultimately the documentation is not that bad, and there may be a chance that you never even need to use that documentation, but I think it will help you rest easy knowing that you spent an hour on the forefront, putting that documentation in place, putting it on files. So that when someone comes knocking, we’re not trying to recreate that in the backroom, we already have all of that already up front and ready.

The Augusta Rule [21:20]

SJ:

Yeah. So our next topic is also one where the documentation is really important to have, really any tax planning topic we’re talking about, but something I always talk about is the Augusta rule, and it’s something that we have certainly shared on this podcast before, we talked about in our webinars, but just in the last couple weeks, I’ve gotten several questions about the actual implementation from members of Retirement Tax Services. So I’m excited to talk about it again, but I feel like taxpayers in general, when I tell them that, “Hey, here’s an opportunity under this Augusta rule to get completely tax-free rental income,” they kind of pause for a second and say, “oh, this must be something…something kind of shady, we must be hoping that the IRS doesn’t notice.” But Nope, we actually still report the income to the IRS, it still goes on Schedule E, there’s some documentation requirements to make sure we’ve done this correctly, but it’s one of the few opportunities I know of where you’re getting truly tax-free income. So Mike, I’ll kick it over to you, because I’d love to hear how you tee this up for clients, as you talk about this potential opportunity?

MJ:

Yeah, exactly. You know, it’s called the Augusta Rule, sometimes known as 14 day Homeland Rule, but it’s called the Augusta rule because of the masters tournament in Augusta, Georgia, and what people were doing is they’re renting out their home for seven days because people come from all over the world to go to this masters tournament, and people that live in the area can rent out their home, make a ton of money for a couple of days, go in a hotel, do whatever they need to do, go visit family and come back. But these people were making this money for renting a home for just a week or 10 days, they were making a ton of money and they were having to pay taxes on it. And so, you know, the IRS kind of looked at this and, and thought deeper on this and said: “you know, that’s not a rental activity, you’re renting your home for 10 days out of the year – that’s not a rental property, that’s simply just kind of a short term situation.” And so that’s when they implemented this 14 day home rental, which basically says that if you have rental income or rent property of yours for 14 days or less, it’s not taxable income to you. Now, any kind of expenses that you have related to that rental is also not a tax deduction for you, but it’s not taxable income if you rent your home for 14 days or less, and so we kind of think about this in saying, okay, that’s great for Super Bowls, and that’s great for golf tournaments and things like that, where we can rent out our home shortly for a lot of money – but how can we think about this as a business owner, you know, how can we get a business deduction? How could we rent our home to our business? We can get a business deduction and we pay no income tax on that income we got from it, as long as the total rental days are 14 days or less, and so this is a great strategy. You know, sometimes we have a shareholder meeting, once a month, so we’re renting out the home once a month to have our shareholders or our board of advisors, which could be family members, could be friends, whoever’s on your board of advisors, that’s who would be showing up to that meeting, but we’re having that meeting say once a month, that’s 12 times a year, under the 14 day home rental or under the 14 day maximum, and it’s just again, a great way to get a business deduction for money that we’re going to spend anyways and not have to pay income tax on it. There’s a few things with it. Obviously we need documentation. Why are we having this meeting? We can’t just be writing ourselves a check and say, “I just rented my house out 14 days and have no proof of it.” So we do want to have that documentation of it. What were the dates of the events? What was the event about? Who was there? Why is it a business deduction? Then another thing is we want to make sure we have a reasonable rental rate. So we can’t just say “my home’s worth $2,000 a day or a hundred dollars a day.” We want to try to find what is that reasonable rate for the type of activity that we’re having there. So if we’re in a board meeting, we might say, you know, how much does it cost to rent out a board room in a coworking space down the road? Or how much does it cost to rent out a boardroom at a local hotel? If we have clients or team members that are staying over our house, what’s a, you know, a rate at a local bed and breakfast or something like that? So it’s kind of finding something that’s comparable to what you’re doing there and making sure you have a reasonable rate. Oftentimes people have done a AirBnB type of comparison, so how much does it cost to rent out an AirBnB, summer side house, things like that, just whatever you use to determine that daily rental rate, just to make sure you have some type of documentation of where that’s coming from. But this is again a very mainstream, completely part of the tax law, allowable way to get a business deduction and pay no income tax on that income you are receiving.

SJ:

Yeah, and it’s not a super commonly used one. So especially as for advisors listening, either for their own business or as you have clients who have businesses themselves, this is likely one they haven’t heard of before, and even if ultimately they decide, you know what, this isn’t a good fit for us, now they know that you’re the advisor in their life who is thinking about these kinds of things and bringing these opportunities to them – I like to call that the dishwasher rule.

MJ:

Yeah, and that’s exactly right. You know it’s not necessarily that you’re demanding that they take advantage of this strategy because everyone’s going to have different risk levels. They might say, “uh, you know, I just don’t wanna do the documentation, I think a reasonable rate is $100 a day, so it just doesn’t make sense to me.” That’s fine, but at least, again, you know, great point that you’re mentioning it – that you do have that…you know…people are gonna look at you and be like, “hey, they’re thinking about me, they’re thinking of ways that can lower my tax liability, they’re not just saying, you know, I’m not going to present any ideas to you and now here you go.”

SJ:

All right, Mike, let’s quickly talk about just kind of high level, some of the things that people should be looking for as they consider whether an S-Corp is the right fit for them. Then we’ll talk about action items and how people can learn more about the resources you offer specifically to small businesses.

Mike Explains S-Corps [27:26]

MJ:

So an S-Corporation is simply a tax election, and it’s one of the very well-used ways to help minimize self-employment taxes. Now basically to be an S-corporation, you need to have an LLC or a C-Corporation set up, and then you’re just electing for that entity to be taxed as an S-Corporation. So with an S-Corporation, we’re not creating a whole new entity or anything like that, we’re just taking your already created LLC or C-Corporation and electing for it to be taxed as an S-Corporation. Now, what does an S-Corporation do? What is the main goal of it? The main goal of an S-Corporation is to reduce self-employment taxes. Right now if you’re taxed as a single member LLC or even a sole proprietorship, you pay self-employment taxes on a hundred percent of your income. So you make a hundred thousand dollars. We pay self-employment taxes, which is 15.3% on a hundred thousand dollars. Now we also pay our normal income tax rate over and above that. So on a hundred thousand dollars, we’re paying a normal income tax rate, and then we’re also paying self-employment taxes at 15.3% on that income. With an S-corporation, we take the rules and change them. So as an S-Corporate election, you are required to take a reasonable salary as the owner of that company. And that reasonable salary is still subject to self-employment taxes. But the beauty behind the S-Corporation is that any income you have over and above that reasonable salary avoids self-employment taxes. So let’s say you have a hundred thousand dollars of income and you say: “A reasonable salary for the work I’m doing, the amount of hours I’m putting in, is $60,000 a year.” We’re going to pay self-employment taxes on 60,000, but we’re going to avoid self-employment taxes on that $40,000, remaining. And that’s kind of the beauty behind the S-Corporation. Now the S-Corporation does come with two main downfalls. One, you need to file a separate business tax return. That tax return is going to be a little bit more complex, it’s going to be a little bit more involved, but it’s a separate business tax return. Now that tax return is going to flow through to you as the owner, so you’re still going to be reporting and paying taxes on that income under personal level, but we’ll have to file a business tax return and then a 1040, which will be your personal tax return. So that’s one main pain point – that for a single member LLC, we’re just filing a Schedule C on your personal return. There’s going to be some costs involved with that. The second pain point is that you have to run actual W2 payroll to yourself as an employee of your business, and so there’s costs with that. There’s software out there that helps make sure you’re paying the taxes, filing the forms and doing all that for you, but there’s some costs involved with that. And so those are the two main downfalls of an S-Corporation. It’s just higher prep costs, we have a more complex tax return, it’s going to cost a little more, and we have to run payroll, which is going to be a monthly charge that we have to pay. And for that reason, we normally say the S-Corp starts to make sense once you’re hitting profit of $40-50,000 or more. If you have a profit of $40-50,000 or less, it’s not necessarily going to hurt you, it’s just much of the tax savings you’re going to get from it are probably going to get eaten up by some of those costs – the additional costs that you have to do that preparation. So that’s kind of why we say, a $40-50,000 in profit or more – let’s start thinking about the S-Corporation. Main reason being is that instead of paying self-employment taxes on a hundred percent of our income, we’re only paying self-employment taxes on the portion of our income that’s a reasonable salary, and then we’re avoiding that self-employment tax on the remaining piece.

SJ:

Yeah, I really liked that you threw it out there, that there needs to be that consideration of, is there enough profit here to make this worth it? Because I definitely will run into people who say ‘S-Corp for everyone.’ Like there’s just this blanket statement. And really when we’re talking about tax planning, there’s almost nothing that can really be a blanket statement, we need to make sure that we understand what the trade-off is because with S-Corp elections, we definitely get to a point where it makes a ton of sense, but out of the gate, it’s not an automatic for everyone. So I really liked that, that framework for thinking about that.

MJ:

Yeah, and one thing with the S-Corporation is that we’re able to also backdate it. So let’s say we open up a business in January, we’re just not sure how that business is going to perform, let’s not rush into the S-Corporation. But all of a sudden we get to September and we’re like, “wow, this thing took off we’re just raking it in, we have a hundred thousand dollars in profit, you know, we’re going to have a great year.” Now we can elect for that S-Corporation be backdated to January 1st, and we can turn that whole year into an S-Corporation. So I would always say, don’t rush into an S-Corporation. Now, the one caveat to that being is that in order to have an S-corporation, you have to have an LLC or a C-Corporation. So if you’re operating as a sole proprietor, we can’t backdate any of that. You would have to, you know…let’s say that happened in September, so January through September, you’d be a sole proprietorship and we’re stuck paying self-employment tax on all that. But then in September, we started an LLC. Now we can do an S-Corporation under that LLC moving forward, but we can’t touch anything backwards. So oftentimes when I’m talking to business owners, I’m saying, let’s not rush into the S-Corporation, but let’s make sure we have an entity structure set up so that when it is time to do an S-corporation, we can easily backdate it to the beginning of the year, and we don’t have to worry about rushing into that.

SJ:

Yeah, that’s really great insight. All right, Mike, we need to get this thing wrapped up here. So real quick, before we dive into action items, just, if you can just share with the listeners where they can learn more about the resources that you offer, because you work specifically with small business owners.

Mike’s Resources [33:19]

MJ:

Yeah, you can find us on the Small Business Tax Savings podcasts. So it’s a podcast that we do. You can find it on any podcasting platform, or you can just go straight to our website, it’s www.taxsavingspodcast.com. We do a weekly episode on tax tips, accounting tips, and then we also do a blog post that, kind of, comes with all three content. And then we also have our tax minimization program on the backend where we dive even deeper into these tax strategies. You have unlimited access to our team to answer these general accounting and tax questions that may pop up along this journey. So again, you can find all of that at www.taxsavingspodcast.com.

Actions Items [33:29]

SJ:

Perfect! Thanks Mike. Now to make sure that we take this information we’re sharing and turn it into real value to you, the action items that stood out to me, and we’re not going to go through each of the topics because this first one really covers a couple of them. The first action item is make sure that you, whether it’s for yourself or with a client, that you have some sort of intentional review process, whether that’s going through your personal account to see if there are expenses there that could have business application, or just going back through it and having this intentional review of where, areas specific to these topics we talked about today, that I haven’t previously seen the connection or the overlap so that we can be proactively taking advantage of these tax planning opportunities. The second action item I’m going to recommend specifically since this is an advisor crowd listening is to make sure you remember the dishwasher rule, which is that we’re letting clients know the things that we’re reviewing and considering for them, even if there isn’t some significant action that comes out of it, make sure your client knows that they’ve got someone in their corner looking for these things, even if they don’t implement the Augusta rule, if this was remotely a possibility for them, they should know that you took the time to evaluate this for them. And then the last action item, which will come as a surprise to no one, is to make sure you’re getting tax returns for your clients every single year, and that you have an intentional process for reviewing those. That’s one of the best ways that we can see which of these might be applicable to them, which opportunities are not currently taken advantage of. It gives us such a great framework for understanding what they currently have going on and the opportunities that might be available to them. So, Mike, just one last time, thank you so much for being here, really enjoyed having you on the show.

MJ:

Thanks for having me on. It’s been a lot of fun and I appreciate you taking the time!

SJ:

And for everyone listening, thanks for being here. Good luck out there. And until next time, remember to tip your server, not the IRS