My first reaction was that the S-Corp gets trickier when income is high but not high enough to phase out of the QBI. But according to every accountant I have worked with, that $60k still flows to your 1040 and you end up paying taxes on it anyway. That sequencing may increase the Section 199A deduction. In this scenario, you also sidestep payroll taxes on that remaining $10K. To assist me with this article, I brought back the tax mastermind who helped me switch my own business over to an S Corporation – my personal accountant, Steve Nelson! Regarding how to approach the question of incorporating your business, you’d need to determinate what your reasonable compensation amount is, look at any nontaxable fringe benefits you can provide, and then calculate your payroll tax savings. If you are able to separate the royalty income from the blog income, then you can re-figure your math and the optics look a lot better. Success! 1. Based on my analysis I believe the QBI deduction does not make it obvious to convert to a S-Corp. that makes $1,000,000. Create New Account. If I’m making ~$30K a year with my LLC, does filing as a S Corp seem worth the hassle? That second trick? If you make over $200K, would it make more sense to not have an S corp and benefit from the QBI on the entirety of your income with SS stopping at $132K? Nevertheless, an S corporation often saves substantial sums. Elton, sorry, I misunderstood… so you’re right that you only pay taxes on your business profit. Same thing for HSA contributions if applicable. Your email address will not be published. The big complicating issue you have with a late election is you’d need to pay Dan the employee reasonable wages between now and the end of the year. That would be the “real” number. The S corporation gambit only works well if you can pay yourself a wage that allows you to really save on your self-employment tax bill. Why? Look forward to any comments if this analysis is off base. Note: In past, CPAs have said you ought to do the employer match first and the employee elective deferral second… but the Section 199A formula sort of flips this around. My question is–do you still get to deduct it as an adjustment to income as self-employed health insurance? I don’t think you generate a financial benefit by setting up an S corporation to create wages so you can fund a pension. And it meshes with the averages pretty well. If you’re a sole proprietor, you pay the 15.3% self-employment on 92.35% of this $100K (as MadFIentist graphically shows earlier). If you’re paying the average, you are pretty boring to the IRS’s computers. The employer match, which appears on the 1120S corporation tax return, reduces both QBI and the shareholder’s taxable income. Notice step 5. But what if you form an S Corp or sole proprietorship, generate income, and create a friendly Solo 401(k) that allows you to convert? The state tax laws may mean the S corporation isn’t viable. If a business makes $100,000 and pays out $75,000 as compensation and benefits, that still leaves another $25,000. He is wrapping up a ... (e.g. Thanks to Steve for making these free for Mad Fientist readers and be sure to get your state’s kit before the end of the year because the code will expire on 12/31/2018! If you’re only going to one and not the other, you probably ought to do the elective deferral first. But to clear up this confusion, I am not suggesting 40%. Is 100k in profits a good ballpark to make this realistic? As someone who actually paid for one of Steve’s S Corp kits a year ago I can confirm it is well done and helped me set up my S corp in Texas. Nobody stays more than five again. Thanks! 2. Note: Boxes 3 and 5 of Diana’s W-2 report only $40K of wages because health insurance isn’t subject to FICA or Medicare. In this episode of the BiggerPockets Money Podcast, the Mad Fientist shares 3 ways to access your retirement funds before the typical age of 59½. Convert t401k to Roth 401k within a 401k plan during periods of low income. Not Now. An S corp that also makes the same $100K but only pays out $40K in wages pay employment taxes on only the $40K. To connect with Mad Fientist, join Facebook today. The biggest problem, however, is the 5-year waiting period, so you have to have a decent amount of post-tax money already available in order to optimally execute on this strategy. Am I missing something? So if you paid yourself 28.5714% of your business profits (which is the percentage that would maximize the Section 199a deductions in this case), you’d be able to get a 20% deduction on $71,428.50 of your income. Log In. 14,214 people like this. Note: Self-employment taxes replace the Social Security and Medicare taxes that employees pay and basically work the same way. Regarding ‘reasonable salary’, if I determine $100K/yr is reasonable for my industry but I am only working 1/2 time, does that help my case to only claim $50K/yr as my salary? If both of the example business owners above have a $10K self-employed health insurance deduction, a $15K pension deduction and another $25K of personal deductions–so $50K in total–that would mean $50K of income subject to income taxes. Pretty cool! Unfortunately, given the S Corp declaration needs to occur by March 15 (and I already have an LLC – any workaround for this?! Furthermore, Steve misses out on roughly $8K or $9K of payroll tax savings. Annually. Required fields are marked *. In my analysis, the S-Corp still had the lower overall tax burden but it was not significant. If your business is structured as a sole proprietorship, you wouldn’t receive any Section 199a deduction because you earn too much to qualify. A lot of people talk about the THEORY of living off investments in early retirement, but how do early retirees actually pay their bills? Given this, do you think it’s worth the effort of going the S-Corp route? Dress up the optics of the tax return. Thanks! Thanks for the post, Steve! You said S Corps are not good for side hustles, but I thought if you work less than 500 hours a year on your S Corp business then you can classify the entirety of the income as profits, not have to call any of it wages, and then pay 0% self-employment tax. So does it matter how you pay yourself after your “responsible wages” exceed 120k a year? That leaves $60,000 you pay out as a distribution to your owner—and on which you pay no employment taxes. How to reduce taxable income is slightly more complicated. “The IRS has ruled that an individual who writes only one book as a sideline and never revises it is not regularly engaged in an occupation or profession, and the book royalties are not considered earnings from self-employment.”, https://www.thetaxadviser.com/issues/2013/dec/kelley-dec2013.html. Regarding a part-time salary, that logically works. Regarding 199A, I actually asked you about this before, and due to the majority of my ‘consulting’ involving actual software design/programming, you suggested I probably wouldn’t qualify: (from your comment) Hi, I opened my S-Corp Jan 2019. Has anyone done a t401(k) to Roth 401(k) conversion to beat the 5-year rule and make their ladder shorter? Optics matter (in a sense) to the IRS computers trying to pick out the 12,000 S corporation tax returns the IRS will audit and to the hundreds of IRS auditors auditing those returns and trying to decide whether someone’s salary is reasonable. Regularly S corporation owners go ape when setting their salaries. Actually, because you’re married, you would need at least $415K in total income to hit the start of the phase out range for specified service trade or business disqualification. I am an independent consultant organized as an LLC. Bummer… I also cannot in good conscience claim to be hiring my wife/kids (a strategy my former accountant was pushing). In 2019, that limit rises to $132,900. Further, this sculpting might be especially compatible with working toward FIRE through aggressive saving and investing. Well, if you did want to do something like this, what you would probably do is immediately form a limited liability company. Learn about investing, tax avoidance, entrepreneurship, travel hacking, real estate, and all things related… Ended up using Intuit Payroll. If your business makes a lot of money (i.e. Read more → The post Military FIRE – The Tax, Investing, and Travel Benefits of Military Service appeared first on Mad Fientist. Obviously, the S corporation tax strategy delivers substantial tax savings. E.g, the typical S corp saves 15.3% on $50K of earnings or about $8K. Based on a 40 hour week, that is ~25%. I’m semi retired, I spend time evaluating real estate deals to see if I want to lend. But to really come out ahead on this, you want to save your payroll tax savings. Brad, two comments about your situation and others like it…. In that case, if that were the only book in my S corporation, I think the right salary number could just be zero. The regulations describe “consulting” as situation where someone provides advice and counsel. Create New Account. Let me issue three cautions before I wrap this up. It would not surprise me if you can save substantial amounts with an S corporation. An icon used to represent a menu that can be toggled by interacting with this icon. To add: the only mention of the 199a deduction in the article provides factually incorrect information. You would need to be able to extract a lot of the S corporation profit as fringe benefits in order to even sort of make this work. This S corp also gets about a $10K Section 199A deduction which probably saves about $1200 in income taxes. Website . – latest numbers here.) or. The Mad Fientist analyses the tax code and looks at personal finance through the lens of early financial independence, he develops strategies and tactics to help you retire even earlier. Both save $16K into a pension. There was an error submitting your subscription. And maybe a little risk exists there…. Minimizing shareholder wages maximizes the “Qualified Business Income” (or QBI) that plugs into the Section 199A formula. bit RHEL6 (x86_64) Juniper SSL VPN, is Network Connect, SecurID and this post on the libgtk2-perl libwww-perl #Download madscientist sudo apt- get … Someone working part-time would logically earn less than someone working full-time. 24k – standard deduction If you've enjoyed the last 9 years of ad-free content and want to say thanks, here's how →, Why You Should Form an S Corporation (and When). Log In. Thanks so much for the informative post. Consider again the earlier example where someone makes $100,000 but pays $40,000, or 40%, in wages. As I understand it, you can only put in 25% of wages on the employer side of the 401k contributions. Currently, I don’t use an Scorp. But it is only 8.25% of total income, far below even the 40% you suggest is borderline. There is a limitation on the deduction as a percent of wages as well, which is where the 28.57% wage number comes in. Throw in the savings on employment taxes described in the post and you can see why this is a great move for many profitable businesses. This benefit alone could save you thousands of dollars! Advanced Strategies for Pursuing Financial Independence - http://www.madfientist.com 13,932 people like this. Toss more into an IRA. Consider the two following small business owners: Both earn exactly $100K. But to determine how much income tax, you need to combine the business profits with all your other deductions: self-employed health insurance, pensions, itemized or standard deductions, etc. Mad Fientist did you a solid on this! Specifically, could an S corp or other LLC be set up for a business that barely turns a profit? E.g., a sole proprietorship who makes $100K pays self-employment taxes on 92.35% of the $100K. Military FIRE – The Tax, Investing, and Travel Benefits of Military Service. But his Section 199A deduction doesn’t equal 20% of $100K. Thank you for considering this request! Withdraw converted amount from Roth IRA, which is treated as a Roth contribution. Regarding book royalties in specific, I think the fact that an author wrote a book X years ago doesn’t mean an S corporation can pay the shareholder-employee “zero.” I get your argument there. Also, the optics of 8.25% might look pretty bad. I see spreadsheets in my future…. And you need to have paid that reasonable salary before the calendar year ends. So if you pay out $285,714 of $1,000,000 in profit as wages, your Section 199A deduction equals either 50% of $285,714 or 20% of ($1,000,000 – $285,714)… either way, the result equals $142,857. (end comment), I will definitely research fringe benefits and also take you up on your generous DIY S-Corp guide offer (thanks!). .5 scale RE, you don’t provide enough info to answer questions… but note that if your total income equals $155K and you’re married, no matter what your trade or business, you qualify for Section 199A. California levies a 1.5% franchise tax on the S corporation’s profit (the franchise tax also is always at least $800). Great article, as I was just recently researching this topic – thank you! Also my CPA told me I only have to file every 6 months, but I read somewhere it should be every quarter. That means paychecks, quarterly federal and state payroll tax returns, tax deposits, etc. Episode 525: Happiness Through Subtraction by The Mad Fientist (Minimalist Finances & Financial Freedom). However, you are clearly in the business of writing. The actual Section 199A deduction therefore equals $12K. 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