Is your LLC costing you money?

Brought to you by Straight Talk CPA with Salim Omar, CPA and special guest Rodney Deloe.

Could your LLC be draining your money?

According to Deloe, many entrepreneurs set up their businesses as an LLC as they perceive that this type of business structure protects their personal assets. 

While this is true, the problem that arises is that there are many cost factors involved in an LLC. 

You will pay more in taxes, including self-employment tax, than you would be with another legal and tax stQructure. Another factor is that you may be saving too little on your retirement plan as an entrepreneur.

How is an LLC taxed?

An LLC is taxed by what's considered the fault of the federal government. 

• If you are the only owner in the business, and you make no other elections, the government will treat you as what's called a disregarded entity or a 'Schedule C'. This means all your profit will be reported on your personal tax return. 
• If you have more than one owner in the business, the default treatment is a partnership. Each owner takes their piece based on their ownership percentage of the company's profits and other items and reports them again on their personal tax.



The business in either case does not pay any taxes on its own. Everything flows back to the individual and is treated as self-employment income on their personal return.

How does an LLC cost a business owner money in additional taxes?

LLCs are pass-through entities. It is deemed as self-employment income. The owner is taxed regular income tax and additionally the IRS will also tax self-employment tax on your profit. 

To illustrate:

The first $147,000 of your profit will be taxed at 15.3%, in addition to the regular tax. Thereafter the IRS will tax you at 2.9%. These make up your contributions for FICA and Medicare that you would normally get on a W-2 that get withheld by the employer. Since you're considered self-employed, the IRS takes both form of tax.

Does an S Corp help save on any of these taxes?

An S Corp is unique. Net profits from an S Corp are not considered self-employment income by both the IRS and most states. Your profit is not taxed by 15.3%. Based on this, immediately on the conversion, you save 15.3%. In general tax bills are approximately $150,000 of income per annum. You then continue to save almost 3%. This is a significant saving for a business owner.

S Corps and Reasonable Wages

When you form an S Corp, the owners are deemed employees of the business. The IRS takes the position, we you not work for free. They expect the owner to draw what is called a reasonable wage. 

There is no clear line in the code about what would be considered a reasonable wage. Thus people have developed their own standards. Deloe's advice is to perform a quick survey, to find out what wage a person with the same job description, in a regular business, is earning. You can use this as an initial baseline for what the IRS would deem as reasonable wages.

How do the numbers work out for an LLC compared to an S Corp

Scenario:

• An LLC business owner who is not an S Corp who earns $100,000, after all his expenses, would pay about 20% on regular income tax on this profit. He would then also pay another 15.3% in income tax. Roughly, he would pay almost $35,000 in income tax on the $100,000 profit. This excluding state taxes.



• An S Corp, in the same scenario, you could pay yourself a $50,000 wage. This is net profit- your wages are seen as a business expense. You would pay regular income tax on $100,000, and then the $50,000 net that you paid that's left from your business. The upside being now $50,000 that still left is not subject to self-employment tax. Your entire amount of your tax is going to be roughly $20,000 saving yourself almost $50,000, because you've avoided self-employment tax.

S Corps and Retirement Savings

There's many retirement vehicles that are allowed for a corporation that aren't available to self-employed individuals.

Scenario:

A single owner is the only employee. If he forms an S Corp, he can create what's called a solo 401K, which allows you to defer money and contribute as an employee. Since he is an employee he can deferup to $90,000 from his paycheck. The business can then match up to $38,500. This scenario does not include any catch-up provisions. The interesting part is the $38,500 business contribution is considered a business expense, that actually reduces taxable income. You get to save money as an owner, reduce your income for tax purposes, and build wealth at the same time. This is a rare moment where you effectively get a deduction and keep the money for your future. 

But you actually can get something and still not have to give up, that you give up access to the funds in the short term, but they're still yours. So it's something that it's a large value proposition for owners and allows them to pretty, basically max out their available retirement deferrals per year, depending on how much income so it's a plus across the board.

Can you convert your existing LLC into an S Corp?

You do not have to form a separate company. You can convert your LLC into an S Corp. It is a fairly straightforward process..

You would need to submit two forms to the IRS. 

• Form 8832, which you tell IRS that you are electing to take your LLC and treat it as a corporation. 
• Form 2553, which is an election by a small business corporation to be treated as an S Corp.

These two forms are all you need to do from a federal level. There'll be some state forms that need filed as well. 
Deloe recommends that people talk to their tax professional to help them file these forms because to avoid mistakes which could be difficult to fix.

Is there any way going back to being an LLC in the future?

Closing Statement

Straight Talk about Small Business Success podcast is brought to you by Salim Omar, CPA. Straight Talk CPAs is a firm which provides individuals with tax return preparation and tax planning. If you are a business, we have a unique approach when providing Virtual CFO, Accounting services, and Tax Planning and Tax Preparation services. Contact us today.