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This module may have a scary title but by the end of it may be your favorite module because this work will deliver some big results.
Two Key Tasks
- Get an EIN Number for your company.
- Elect to have your new company treated as an S corp.
Then we will learn about effective expense management and tax management.
TASKS FOR MODULE FOUR
I wanted to cover some basic issues about taxes before we get into the activities.
Income Tax Nexus
This is basically who you owe income tax to in a given period. In the United States, If you are a US Resident and you have set up an LLC when we are done with this module you will have a personal income tax liability for the company profits and what income you draw as a wag to the Internal Revenue Service. You may also have a state and in some cases a municipal income tax. This will be driven by;
- your residency where you live for 51% of the year,
- have your primary residence,
- drivers license
Example If you live in California but you incorporated in Wyoming you pay income tax in California and Federal Income Tax.
Scams and Fraud
Uncle Sam doesn’t call. Uncle Sam has to give you due process. You will never get a legitimate call that requires you to wire money or your house will be seized. If you do owe back taxes or make a mistake you will get a letter. In the case of your business to the registered office and you typically have 45 to 90 days to resolve the matter. Picking up the phone is a great way to start getting resolution.
They will be happy to work out some type of payment plan or help you to get the right forms filled out.
EIN & S CORP ELECTION
When you’re done with these next two tasks you will have wrapped up the bulk of the mind-numbing administrative work of setting up a business. You should be really excited because you will be done with that work and you will have set up your company so that you can save significant taxes. Essentially what you will have is a separate entity that you are the owner of and you can be an employee for. You will learn more on this subject in Module nine. There we will discuss how to extract money out of your business in the most efficient way, but to do this we need to do these last two steps.
Getting your Employer Identification Number
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This information is the same regardless of the state you file in. You will need a separate Employer Identification Number for your business this is its social security number and vital for getting bank accounts, PayPal, KDP and business accounts. Every business needs this to get set up. Watch the walkthrough video then open the link below in a new window so you can revisit the walkthrough video as you complete the process.
You should get an email from the IRS within a few hours with a PDF of the SS-4 form. Save this record we will be showing you where to save these files in the next module.
Remember we discussed the difference in a C and S corporation?
We learned that it was a tax treatment and nothing to do with the corporate structure. The beneficial treatment can be applied to an LLC so that we get the best of both worlds incorporate flexibility and options with taxes. Later we will discuss how to use this treatment to optimize your taxation.
So why elect to be subchapter S?
This is about more than tax liability reduction it is about giving you options and we like options.
1. Wages & Distributions versus Guaranteed Payments, Payroll tax Vs Self Employment Tax
If you have an LLC it is a pass-through entity and tax rules say you can’t be paid a salary. You can get regular payments, but it is shown as a distribution, not wages and you have to pay self-employment tax on the whole of the profits. Once you elect to be an S Corp you can pay a salary and you’re your tax liability will drop because you no longer have to pay self-employment taxes. Now the business pays a payroll tax. The difference comes in that you will take a portion of the company profits as salary
Salary formula: I suggest 50% of the business profit of the as salary up to the FICA cap currently $128,000. The rest can be taken as a distribution and not have a payroll or self-employment tax applied saving around 16%
You can not underestimate the power of the W-2. The credit approval system in the United States is hung on it. Being able to show a loan officer a W-2 is the difference of several points of interest and a ton of paperwork for approval. That one piece of paper verifies income easily even though you are self-employed.
3. Tax Payment Withholding Vs Quarterly payment
Now that your being paid a salary you can move your tax payments to be withholdings from your paycheck rather than Quarterly payments. You will need to do some calculating as to what to withhold but if done right it should eliminate or greatly minimize any quarterly tax payments. Using a payroll system you now have automated your tax payments and have gotten another thing off your plate.
4. Qualified Business Income Deduction
This is a tricky one but you there may be a qualification for up to 20% of your business income to be tax exempt. This needs to be evaluated on a case by case basis and is tied to if you are married or single, the amount of profit, balanced against the amount you pay as W-2 payroll. The wind up is this is the new tax laws will require you to tinker with what you pay yourself via W-2 and take as distribution to maximize the deduction and reduce your tax burden,
All of this is now available to you as an owner of an LLC that has elected to be treated as an S Corp.
Now what you need to do is ask the IRS to treat your new company like an S-corp. This requires you to fill out a form sign it and mail it in. They will get back to you by mail about the approval. Seeing as this is a new business it is rarely ever refused.
Step 1: Watch the video
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Step 2: Download PDF and fill out
Form 2553 Sub Chapter S election ( I let you download the form directly from the IRS so it is the most up to date.
Step 3: Mail the Form to Uncle Sam
Here are the addresses
TAXES AND HOW THINGS WILL BE DIFFERENT
With all of these items in place;
- LLC Chartered
- EIN in hand
- S Corp Election approved
You and your business are now separate.
With your company set up and your election to an S corp, you will now have to;
- file a tax return for your business each year. That Tax return will tell the IRS how much money your company made.
- You will need to file a K-1, this form to tell the IRS who got what portions of that income.
- That all needs to be done before your personal tax return because the K-1 will be reported on your personal return.
- You filed an IRS 1040 Tax Return
- You Itemized business Income & Expenses on a Schedule C
- You paid Self Employment Tax on your total income shown on your Schedule C
- You will file the 1120S S corp tax return. It must be filed by the 15th day of the third month after your tax year ends. This should be March 15th.
- You will issue a K-1 to yourself to document the income tax you owe. The company is a pass-through entity and doesn’t pay tax. You do at the personal level. Keep in mind you pay taxes on income even if you did not distribute it to yourself. Retained earnings will have income tax associated with them and you may need to provide a dividend to cover taxes.
- You will File a 1040 Tax Return This is your personal tax return and will determine your tax owed
- Income will be shown on Line 7 (your W-2 )
- Income will be shown on Line 9a (dividends)
Your first year you will need to be careful with where things are to be claimed and you may need to file both for the business and a detailed schedule C (Yuck!), but this will only be one year.
If you make more than $500,000 you have an additional form the 1125-E that documents the salary paid by the company.
I will go into detail in the expenses module on how to categorize expenses so they align well with the lines of the 1120S. This will make it so you can easily do your own taxes, or expedite the time your CPA requires on your tax returns.
In this new set up all your business expenses are up in the business not itemized on your schedule C.
In the expenses module, we will cover your salary and how to split your income between your W-2 and dividends. As a rule, we want to see a 50/50 split dividends to salary. You no longer pay self-employment tax outside of your and the company portion of your W-2 salary. This means you just picked up all the SE tax on the dividend portion. In my typical example of $100,000 in profit split between the two you just picked up $8,000 in SE tax.