40% Tax on Profits!? Shut the Front Door!

That’s what the man said over the phone anyway!

That just doesn’t make good #businesscents to me!!!

Essentially, If I do business as a Sole Proprietor (essentially as a #selfemployedidiot), it sounds like this:

  • I’ll have to pay 25% taxes to the federal government for things like Social Security and Medicare
  • I’ll also have to pay 15% on self-employment taxes
  • so, yeah… that’s like #40friggenpercent straight to the government….
  • #cheersforthatonegovna

However, it would appear that there may be a better way for a small business like mine to pay less in taxes… …. … but I’m only just working it out.

So far, here is what #ithink I have learned:

  • Start either a Corporation or an LLC but choose the Subchapter S election
  • Then you only pay a portion of the taxes… well…
    • You still have to pay the Medicare and Social Security tax but only on the portion you take home as your salary
    • Which could be 50% or even less…
    • I have heard about the 1/3rd  2/3rd split, but haven’t read about it anywhere to confirm. But, it appears that you can pay yourself as little as 1/3rd from the profits and the rest (2/3rds of the annual business profits) is called … distributive share
    • Now, you’re still paying taxes on the full profits, just not the 15.3% sefl-employment taxes on the full profits…
    • So you’re still paying some 25% against your full profits but you’re saving the 15.3% (that you would also be paying against the full profits if you were registered as self-employed/sole-proprietor) on the portion that is not considered your salary/annual wages.  …

 

In other words, if you made $100,000 for the year you could:

  • Sole Proprietor 100,000 –
    • Self-employment tax = 15,000
    • Federal Income Tax = 15,000
    • State Income Tax = 10,000
    • Total Tax paid = 40,000

 

  • Subchapter S corp/llc
    • Your Salary – 40,000
      • Self-employment tax = 6,000
      • Federal Tax = 6,000
      • State Income Tax = 4,000
      • Sub-total = 16,000
    • Distributive Share – 60,000
      • Self-employment (Medicare/Social Security) = 0
      • Federal Tax = 9,000
      • State Tax = 0 (?!?! – #idontknow) / or it could be another 6,000
      • Sub-total = somewhere between 9,000 & 15,000
    • Total taxable Income for the year = 25,000 / 31,000

No matter how you look at it, you are saving somewhere in the region of 9 to 15 thousand dollars a year in taxes.

So… #whatstherub you ask?

You are almost definitely going to have to:

  • Incorporate your business into an LLC or Corporation and elect the Subchapter S option
  • pay a CPA to get you off on the right track – from $250/$800
  • handle both your Business and Individual/family taxes – from $800/$2000 depending on complexity
  • set up a separate business bank account – free to $180/annum
  • Get QuickBooks ($40/month) or another Business Finance Management tool – I just happened upon this free tool http://zipbooks.com (again, no affiliation to me) which looks very promising!

So, you will have to pay money, but should end up ‘saving’ money by paying for the privilege.

So what is the ROI for your venture…? With probably say $3000/year expenses to pay for professional assistance, you likely need to be projected to earn in the region of 50,000 per year (or more).

Are you with me? Still sounds like we better be incorporating.

What do you think? Have I gotten something wrong in this? Please be gentle, remember, I’m only just starting, but if you happen to have a more complete idea or better yet, experience with juggling these kinds of taxes, leave me your input in the comments!

 

And now for your listening pleasure:

 

Initial thoughts from this blog came from Stephen Nichols! Thanks for helping me begin the long trek to figuring this out.

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