It gets tricky when your profits get high and the effort of setting up and maintaining an S-Corp becomes more questionable. The 12.4% Social Security stops at $132,900 (2019) in income so if you want to max out a solo 401K (assuming a 25% employer contribution) you'll need to have $148,000 in W2 income ($19K from the employee and $37K from the employer to hit the 2019 limit of $56,000).
So at that point you've already paid all of the Social Security tax possible for the year and the S-Corp advantage is greatly minimized as you only continue to save on the 2.9% medicare tax. That's still something though as there is no cap on that tax.
S-Corp is significantly more work than a standard LLC. You'll have a separate corporate tax return and use the K1 for your personal taxes. You'll have to run payroll as you as an owner will now be a W2 employee and deal with workers comp, unemployment and all sorts of other fees and taxes depending on your state (for example here in WA they just started a paid family medical leave tax on gross wages up to $132,900). Some you'll be exempt from as an owner/employee and others you won't.
There is a lot more to the subject for sure, but those are a couple of highlights to dampen the mood of the idea of huge tax savings...
Honestly - it's not. I pay Quickbooks ~$50/month where I click one button every month and it pays me my "salary" and then pays social security. I then pay my accountant to do all of the tax prep (which I would do S-Corp or not).
- The change to a W-2 employee for my partner and I meant setting up a proper accountable plan for expense reimbursement. So submitting expenses to the company, recording proof of purchase, etc. and that being processed as non-taxable income via payroll.
- We had to switch from our individual SEP IRAs and setup a Solo 401K. Not a huge deal to set up, but definitely more work as contributions on the employee and employer side are both done manually every month for each of us.
- Instead of a single check per month now there is compensation via payroll and I have to separately calculate and process the distributions for each of us afterward.
- HSA and medial insurance reimbursement is a total pain. We use Gusto and we have to have them make a manual adjustment to the W-2s at the end of the year in order for them to accurately reflect this reimbursement as it can't run through the accountable plan and their system cannot properly process this type of reimbursement. I actually had to have them issue my W-2 3x this year because they did it wrong the first two times. This is another perk of the S-Corp that I forgot to mention earlier though as healthcare reimbursements are counted as W-2 income, but are not subject to FICA taxes. So that increases the income eligible for contribution to the 401K without FICA being paid on it. $7,000 is the 2019 limit for HSA (for a family) and the health insurance is whatever it is in addition to that.
- The setup was definitely a major hassle for me. We had to register with various city and state agencies even though we are exempt from many of those taxes as owner/employees. It took us around six weeks in total to set all of this up.
- One last addition. In order to divert more pre-tax dollars into investments I hired my wife to help part time to work enough to max out her employee contribution to her 401K and then the company adds 25% to that since all employees must have the same employer contribution through a solo 401K. That's not specific to an S-Corp, but it is a good way to save another chunk of pre-tax money for those that are married and in a position to do so.
Well ya there ya go. If you're a sole proprietor then it makes a lot of sense. Start bringing other people on and it gets way more complicated.
Making your wife/husband a shareholder is common too. In the UK you get a personal tax free allowance plus a certain amount of tax free dividend. If your spouse doesn't work (or pays a lower rate of tax than you) then you can make a big saving this way by paying some money to them instead of you. Maybe they can get a job as your bookkeeper? This can serve to pull you out of the top tax rate bands, or at least pay the higher rate on less of your income.
1- Push as much expenses as legally possible to the business. Lease (buy a car on a lease). Depending on the country, there might restrictions on how luxurious the personal/business car is. By leasing you deduct the interest. So there is literally no reason why you'd not do it.
2- Only "pay" yourself the minimum required. That is, how much is your personal rent, food and other. Pay yourself that. Don't pay yourself from dividends. Make yourself a salary. That can be helpful if you are getting a loan on the business and on your personal account.
3- Do not pay dividends if you made profit. Always re-invest or suck profits on some way or another. This will make your tax rate effectively 0 but you'll notice that the government has always ways to suck in taxes.
I'm not in the US, so YMMV.
1) This may not be true. In most countries you would get a capital allowance that means you could make this saving even if you buy the car outright. There are also different kinds of lease that have different tax effects. In the UK VAT on a contract hire is 50% disallowed if you use the car personally for instance. Another reason this might be a bad idea, driving the companies car for personal use may be a 'benefit in kind' and taxable at a high rate. In many situations it is better to buy the car personally and record business miles and claim it on expenses at a government approved rate per mile. Talk to an accountant, it depends on several factors.
2) Many countries have minimum wage legislation. Don't pay less than that!
3) This is far too general to be true. If you can afford it and are planning an exit then leaving profits in a company can be great. This presumes that there is no better user for the money, which is not something you can generalize about.
Disclosure: I'm in Finance, but not a tax specialist.
I guess I get it now when some here comment: Check a lawyer. Check an accountant.
Better advice (or what I'm doing):
1- Check the laws/rules yourself. Just get a rough idea.
2- Suggest your creative ideas to your accountant and see if he agrees.
3- If your accountant is not aggressive in saving you taxes, maybe it is time to shop for a new accountant.
https://www.gov.uk/hmrc-internal-manuals/national-minimum-wa...
Still, you're right. Talk to an accountant. I use these guys: https://www.maslins.co.uk/
> The national minimum wage does not apply to company directors unless they have contracts that make them workers as defined in section 54(3) of the act.
I suggest if you are a single freelancer in the UK you may easily fall foul of that. Remember employment contracts can form without you writing them down. I know of cases where this has happened. If you only come into work for board meetings then sure, avoid minimum wage.
But then if you are a single freelancer in the UK you will already be talking to an accountant to discuss IR35...
I'm not overly worried about an implied contract between myself and the company I own and direct. It's also generally the advice of accountants and legal professionals that it is fine to operate this way.
Also, snark aside, I get my contracts reviewed by QDOS, act outside and have an accountant. Anyone considering being a freelancer or contractor in the UK needs to be aware of IR35 and should get an accountant. Mines is https://www.maslins.co.uk/
It is almost guaranteed that I pay less to drive my 2005 Honda CR-V (paid entirely with taxable dollars) than a business owner pays to lease a newer Honda CR-V paid with pre-tax dollars. (So, that's one reason why you might not lease a car for your business.)
If your principal place of business is your home office, then driving to/from additional client sites likely is a business expense.
But if you are the type of freelancer that goes and works on site on a regular basis for your clients, then the IRS will likely try to assert that your client offices are actually your "place of work" and driving in to see them is merely a non-deductible commute.