Join us for another episode of Tax Hacker Tuesday featuring talented Tim Berry. Today we discuss how to save taxes with business entities and what type of structures you should consider when establishing your business. Take a moment now to learn how you can keep more of the money you make as a real estate investing entrepreneur.
It’s all here on Tax Hacker Tuesday!
What You Will Learn About How to Save Taxes with Business Entities:
How to structure your business for asset protection
- How you can boost your business and save taxes with business entities
Different types of business structures and what you should choose
Tax liabilities and how to manage them
The proper business entity for you
How a sole proprietorship works
Other entities that should be considered
Tax attributes of various business entities
How to keep more of the money you make as an entrepreneur
How an LLC works and when it applies
The benefits of C-corporation versus S-corporation
Why you should consult with your tax professional on establishing your business
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Matt Theriault: Hey there. Rockstar Matt here.
On Mondays, I’m gonna continue to show you how to make money. On Tuesdays, however, my buddy Tim and all his friends are gonna show you how to keep it. Enjoy the new show.
Speaker 2: This is Theriault Media.
Did you know that up to 50% of your lifetime income will be wiped out by taxes? What if you could stop this madness? Isn’t it about time you played on a level playing field with the wealthiest 1%?
Now you can. Tim Berry, attorney at law, shares here each and every week current tactics and strategies that anyone can implement to hack the tax code. Protect your assets and keep what’s rightfully yours. It’s time for Tax Hacker Tuesday.
Bernie Gartland: I’m Bernie Gartland, tax attorney. Tim Berry, tax attorney. We’re gonna talk about structuring your business. How are you gonna structure your business? What is the best form of your business structure?
Tim, why don’t you tell the folks about the different types of structures that there are because many of you don’t even understand or have knowledge of that. Even as a sole business owner, you can have different structures. Why don’t you, as we say in our – “edumacate” them?
Tim Berry: “Edumacate” them? Okay, well, let’s talk about business entity, business structure, and the basic question: Why does this matter?
Well, it matters for two main reasons. Number one, we got tax issues. Depending upon what business entity you use, you may or may not be entitled to certain tax deductions, and you may or may not have to pay self-employment taxes on the income you generate. By the way, self-employment taxes – that’s a 15.3% additional hit over your regular income taxes. For many people, they pay more in self-employment taxes than they pay in income taxes. That’s one reason, is the tax issue.
The other one’s asset protection. Bernie, how many times a week do we have people come in – they have a corporation; their corporation ran up a tax bill of a few hundred thousand dollars. Now, are they personally liable for – and just on a simplistic level – are they personally liable for the debts of the corporation?
Bernie: Well, the tax liability of the corporation, they are not personally liable for, but there are other areas which we’ll cover a little bit later that, hey, folks, if you’re gonna do a corporation, you gotta make sure you make your federal deposits for your employees – or else.
Tim: Yeah, but the simple, basic answer? They could rack up a big corporate tax bill – and this isn’t saying they did it intentionally or fraudulently; we gotta throw out all those other disclaimers, we gotta act like attorneys at least – but they could rack up a big tax bill on their corporation and theoretically, they could walk away from it. Let’s start going through the various business structures, business entities-
Bernie: Let me interrupt you for a minute.
Bernie: We just recently had that case that we’re working on, as you know, is that we’re working the guy owed $80,000 in personal taxes, and lo and behold, there was a tax work decision that made his corporation liable for an additional … His corporation liable for an additional $200,000. And the representative from the IRS, the collection specialist, calls me on the phone and says, “I guess you’re gonna file bankruptcy on the corporation to get rid of the $200,000 because it doesn’t go over to him personally.” And even the IRS is aware of that, and he’s suggesting, “Go into the bankruptcy, get rid of the extra $200,000 for the corporation, and let me deal with you on the guy’s personal taxes.” I thought that was very admirable of the IRS to give me that call.
Tim: Yeah, very nice. And long and short of it on that, $200,000 wiped out.
Tim: Just by using the proper business entity.
Tim: What are the business entities?
First one is the default, and this is the one that 80% of businesses are, and that’s the sole proprietorship. That’s where you just decide to open up a business and call yourself a business, and bam. You’re now in business. You’re a sole proprietor.
Now, why do you think 80% of businesses are sole proprietorships? Mr. Gartland?
Bernie: There’s a couple reasons. One, it’s very simple. “Hi, I just got a business license in the town that I’m in.”
Tim: I’m imitating Mr. Rubio, by the way.
Bernie: And I’m in … Pardon?
Tim: I’m imitating Mr. Rubio. I had to reach over and get some water.
Bernie: Oh. Oh. Oh. [inaudible 00:04:22] the bottled water, and you didn’t give you any dip like this. Anyway, it’s very simple just to get your business license, and you’re in business, and you use your own social security number.
Number two… I hate to say this, folks, but it’s kind of lazy because this is very simple, and I don’t want to get involved in other structures that may protect me, but I have to do a little bit more work. Or number three, I think that what happens is that a lot of people that are creating their businesses don’t seek professional advice prior to setting up their business, and they just don’t know about the other entities, and the tax savings, and/or the liability that you suffer as a sole proprietor.
Tim: Let’s go into that for just a little bit. If I make $100,000 net profit in my sole proprietorship, how much of that is subject to self-employment taxes?
Bernie: Well, you got 15.3% of the maximum.
Tim: Yeah, and the maximum’s over $100,000, so the full $100,000? I get an additional $15,300 in taxes just by using the default sole proprietorship.
Bernie: That’s true, and the thing of it is with that is there’s another entity that allows you to still have that income-
Tim: But let’s hold off on that.
Bernie: But you don’t have to take the 15.3%, but there’s another entity, and that’s the reason why you should, if you are to open up a sole business – you should seek professional advice so that you can do what we’re gonna talk to you in a minute.
Tim: Got it. So the sole proprietorship – 100% of the income earned is going to be subject to the self-employment income.
Let’s say I rack up a bill of $300,000, a tax bill of $300,000 – can I walk away from that tax debt?
Bernie: If it’s a sole proprietor?
Tim: Okay, so sole proprietorships make no sense. They’re for the uninformed and for the lazy, so I ask you: Are you uninformed and lazy? Little bit of facetiousness there, everyone. Okay, so-
Bernie: Was everybody supposed to raise their hand and say, “Yeah.”
Tim: Yeah, they are.
Bernie: “Yeah, I’m lazy.”
Tim: Hey, you in the back, there. I see you. Okay, so sole proprietorship doesn’t make sense.
Second one: LLC. What’s an LLC? An LLC is a limited liability company. Not corporation – limited liability company, and that’s basically pretty much like operating as a sole proprietorship, but you have limited liability with that entity.
Now, the cool thing about the limited liability company is you can shape and mold that thing pretty much however you want to, and you can have that taxed either as a sole proprietorship, you can have it taxed as a partnership, or you can have it taxed as a corporation.
In most places, an LLC is a great starting block to set up before you determine how you want to be taxed. LLCs are great little pieces of play dough, basically, on how you can shape and mold things. And let’s go into the corporations, also, because now we have the other entities of corporations.
In particular, let’s talk about the tax attributes of the corporations. Bernie, whenever we’re talking about the sole proprietorship, you started to talk about, “Well, there’s another entity where you can lower the amount you pay in self-employment taxes.” Please, explain.
Bernie: There’s a sub S corporation. In a sub S corporation, as long as you pay yourself a reasonable salary, you can… Let’s take that $100,000, for instance. Let’s say you gave yourself a reasonable salary of $30,000.
If you were a sole proprietorship, you’d have to pay 15.3% on the entire $100,000, but if you give yourself a reasonable salary of $30,000, let’s say, and the $70,000 that you can attribute to your workers that are your employees that are working for you, that you can show produce that profit, that extra $70,000, you don’t pay the 15.3%. It’s called either a dividend or a pass-through profit.
By the way, I have been through many, many audits with the IRS that they’ve allowed this only if you take a reasonable salary, and-
Tim: Hold on, hold on. Don’t be an attorney on me. I want black and white. How do I define “reasonable salary?”
Bernie: Well, whatever a person would earn in the market. I mean, if you are an entrepreneur and you pay yourself $500,000 a year reasonable salary, that’s not reasonable salary.
Tim: Mm-hmm (affirmative).
Bernie: You know, your reasonable salary… Let’s just say $30,000 or $35,000, and just think of the savings. You can save $6,000 to $10,000 – sometimes $12,000 a year alone – and that doesn’t include our topic of last year, last week with the 401(k). That’s a whole different issue this week we covered, but the-
Tim: Let me stop real fast. How about Bureau of Labor Statistics. Can we go to the Bureau of Labor Statistics? They have a website, and it says, “Here’s what we think a reasonable salary is?”
Bernie: Absolutely, and the government relies on that.
Bernie: There’s a lot of practitioners out there saying, “Oh, don’t do that. That’s a high audit risk.” No it isn’t. Even if it is a high audit risk, if you got your ducks in order, you pass the audit.
Tim: I agree.
So with an S corporation, it can be a fantastic tax savings vehicle so long as you pay yourself a reasonable salary. One source of finding out what a reasonable salary would be would be the Bureau of Labor Statistics.
Other corporation out there is a C corporation, and with a C corporation, the entity itself is the taxpayer. With the S corporation, the tax ramifications flow through the S corporation, and it’s the owner of the S corporation who pays the taxes. With the C corporation, all of the tax ramifications flow into and stay inside the C corporation, and now the C corporation pays the taxes. C corporations, for starters, for people just starting off, they’re probably not the best choice. Either the LLC or the S corporation’s probably gonna be a better choice, but as you start getting more advanced with things, then the C corporation might make sense.
One caveat about a C corporation: never put real estate, never put appreciating assets inside a C corporation. It’s gonna be a nightmare. It’s gonna be a disaster.
Now, let’s go back to the LLCs real fast. I said they can be taxed as a sole proprietorship, they can be taxed as a partnership, or they can be taxed as a corporation, either a C or an S. How do you go about doing that?
Well, it’s really neat. You create the LLC, and now you just file the proper forms with the IRS and you tell it you want to be taxed as a corporation, either a C or an S. For most of you starting out, setting up the LLC’s gonna be the way to go, except for a quick caveat. If you live in California and you have a professional license, you can’t operate with an LLC. Then you gotta go directly to a corporation or use the sole proprietorship, but for a lot of you starting out, you probably want to use the limited liability company and then determine the proper tax attributes for it, and utilize the entity that has the best tax attributes, the corporation, the partnership, or the sole proprietorship.
Bernie, we talked about it before but let’s hit it again. With the corporation, if I rack up a big tax bill and it’s not payroll taxes.
Tim: I can have a viking funeral? Just push it off, catch it on fire, and all those tax liabilities go?
Tim: The big takeaway from today’s class, if you will, is: Don’t use a sole proprietorship. Do not use a sole proprietorship. Look at establishing a regular business entity, and if you have questions on the proper taxation of that business entity, by all means, give your professional advisor a phone call.
Speaker 2: That’s it for today, as we dream of a tax system that works just for you, but until then, you have Tim Berry. See you next Tuesday for another episode of Tax Hacker Tuesday.