TAX TIPS (and other stuff)

By Kelly J. Bullis, CPA

In our CPA firm, most of our business clients are taxed as Sub-S Corporations. That is not by accident. Over the years, our tax philosophy for small businesses has been to work towards becoming a Sub-S at some point.

Here’s the problem with the other options.

A single member LLC is taxed as a Schedule C on a person’s tax return. All profit pays regular income tax and, ALSO self-employment tax (at a tax rate of 15.3%) Ouch!

A multi-member LLC is taxed as a Partnership. It files its own tax return, but the net income flows through to the owner’s personal income tax return, and, like the Schedule C income, is also subject to self-employment tax of 15.3%.

A regular C corporation files its own tax return but pays its own income tax at a current flat rate of 21%. So far, that sounds like the best solution. Well, for small business owners, it isn’t usually the case. Small business owners run their business with the express purpose of generating income for them personally. That is where a C corporation has a problem. You can either take profits out in the form of W-2 salary, all subject to Social Security Tax, which the business pays too, essentially, still paying a total of 15.3% on the salary. Or you can take profits out in the form of dividends. After the corporation pays tax on the income, you as an individual pay tax again on your personal return for any dividends you take out. (Good news is that those dividends are taxed at Capital Gains tax rates (lower than regular income tax rates).

Usually, the best arrangement is to be taxed as a Sub-S. In that case, you report the business activity on its own tax return, but more like a partnership, you pass those profits through to the owner’s personal tax return. The best part is that all those profits are NOT subject to the 15.3% self-employment tax.

There is one caveat though. IRS requires you to pay the owner(s) “reasonable salaries” for services performed. Simple definition of that is, “Pay what you would pay somebody else to do that job.” That portion of the profits paid out as “reasonable salaries” is subject to Social Security tax (and the business pays it too, so 15.3%). But, the rest of the profits don’t pay that self-employment tax, which sometimes is significant.

There are always exceptions to every general rule. So, it’s always best to talk to your CPA about all of the issues to take into consideration before making the final decision.

Have you heard? Prov 16:16 says, “How much better it is to get wisdom than gold! Yes, to get understanding is to be chosen rather than silver.”

Kelly Bullis is a Certified Public Accountant in Carson City. Contact him at 775-882-4459. On the web at BullisAndCo.com Also on Facebook.

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