Business Successful, Question About Paying Ourselves

[thef0x]

My business partner and I own an LLC, just two of us, now successfully making solid $$ each month.

I'm wondering for myself (individual taxes), what is the best way for me to be as an entity (sole proprietor vs owning my own LLC) so that I can reduce my personal taxes the most? 

I'm green when it comes to minimizing individual taxes but cannot take advantage of a 401k but I can take advantage of working from home, right?   Would love advice on practical deductions for someone in my situation (partially owns a business which he is using to pay himself)!

Thank you all so much!
-Denny

[DaveR]

Often, once you get to a spot where a business is making solid money, an S-Corp provides the best tax situation. You pay a fair wage (subject to payroll taxes) but can make distributions beyond that.

Under an LLC, there isn't anything that prevents the company from setting up a 401k or SEP IRA to get some tax advantages. Other things to look at: health insurance, automobile expenses, and business use of your home.

The proper way to do all of this is through the LLC, not individually, so you, your business partner, and accountant/tax pro should all sit down and do a little planning.

[Vilgan]

My business partner and I own an LLC, just two of us, now successfully making solid $$ each month.

I'm wondering for myself (individual taxes), what is the best way for me to be as an entity (sole proprietor vs owning my own LLC) so that I can reduce my personal taxes the most? 

I'm green when it comes to minimizing individual taxes but cannot take advantage of a 401k but I can take advantage of working from home, right?   Would love advice on practical deductions for someone in my situation (partially owns a business which he is using to pay himself)!

Thank you all so much!
-Denny

LLC isn't the part that matters so much as even with an LLC you'd normally be taxed as a sole proprietor.

The important part after you create the LLC is to opt to be taxed as an s-corp. If you've had the LLC for more than 3 months, you'll have to wait for the next year (aka January a month from now) to make the election. Otherwise you can make it now.

Key good things about opting s-corp:
You can significantly reduce how much you pay in self employment tax by taking a lot of the profit as a draw rather than as w-2 income. You still need to take a reasonable salary, but if that's 60k and you are netting 100k, that's 40k that you don't have to pay SE tax on.

Downsides:
You'll now need to pay unemployment tax
If you have w-2 income from full time employment you might actually end up paying more SE tax than normal
Less flexibility on splitting up the income

Other good things to look into:
Yes you can get a 401k and should!! google solo 401k or individual 401k. These are typically free and available to you and your business partner.
401k Profit sharing (Very good to do, applicable for partnerships and owner only s corp)
Understanding your various business expense deductions like internet, phone, mileage, home office (if applicable)

Key thing on the 401k is get it set up before the end of the year. Even though you can make profit sharing contributions until the tax deadline, if the plan didn't exist on Dec 31, you'll miss out.

[thef0x]

Great advice!


We are not quite ready to file as an S corp so on to the other things:

I can open a 401k for free with Schwab.

I have $5,500 maxed in my Roth IRA.

I have $23,000 in my individual accounts.

I have $0 in an individual 401k.

How do you suggest I distribute money to the 401k and also:  how hard is it to take the 401k money out before I'm that old?  I'm worried it's just money I'll have no access to (but how much money should I have "access to" vs in retirement accounts that I won't even touch)?

Tax deductions:  if I am paying for them on my personal card, can I still file them as deductions?  Or do I file those deductions as self-employment deductions?  Do I file tax deductions via the business or my individual taxes?

Would love more thoughts on this!  Huge help!
-Denny

[Frugalman19]

My business partner and I own an LLC, just two of us, now successfully making solid $$ each month.

I'm wondering for myself (individual taxes), what is the best way for me to be as an entity (sole proprietor vs owning my own LLC) so that I can reduce my personal taxes the most? 

I'm green when it comes to minimizing individual taxes but cannot take advantage of a 401k but I can take advantage of working from home, right?   Would love advice on practical deductions for someone in my situation (partially owns a business which he is using to pay himself)!

Thank you all so much!
-Denny

LLC isn't the part that matters so much as even with an LLC you'd normally be taxed as a sole proprietor.

The important part after you create the LLC is to opt to be taxed as an s-corp. If you've had the LLC for more than 3 months, you'll have to wait for the next year (aka January a month from now) to make the election. Otherwise you can make it now.

Key good things about opting s-corp:
You can significantly reduce how much you pay in self employment tax by taking a lot of the profit as a draw rather than as w-2 income. You still need to take a reasonable salary, but if that's 60k and you are netting 100k, that's 40k that you don't have to pay SE tax on.

Downsides:
You'll now need to pay unemployment tax
If you have w-2 income from full time employment you might actually end up paying more SE tax than normal
Less flexibility on splitting up the income

Other good things to look into:
Yes you can get a 401k and should!! google solo 401k or individual 401k. These are typically free and available to you and your business partner.
401k Profit sharing (Very good to do, applicable for partnerships and owner only s corp)
Understanding your various business expense deductions like internet, phone, mileage, home office (if applicable)

Key thing on the 401k is get it set up before the end of the year. Even though you can make profit sharing contributions until the tax deadline, if the plan didn't exist on Dec 31, you'll miss out.

Great advice, couldn't have said it better. S-corps are getting audited a lot more, just make sure you are taking a fair wage for your profession. Then take the rest as a distribution, not subject to the payroll taxes.

[dandarc]

How do you suggest I distribute money to the 401k and also:  how hard is it to take the 401k money out before I'm that old?  I'm worried it's just money I'll have no access to (but how much money should I have "access to" vs in retirement accounts that I won't even touch)?

http://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

[thef0x]

Question:

Do I setup the 401k for the business that is currently making money (from which we are paying ourselves), e.g. the LLC, WHEN there are 2 of us?

-- How does this work with individual 401ks when there are two ppl full time?

-- Implication: 401k setup under E-IN

OR Do I setup a 401k for myself as a "sole proprietor" (e.g. my "revenue" is my income and my "business expenses" are my home office), and I'm the only one on the plan?

-- Implication: 401k setup under SSN

[Vilgan]

Question:

Do I setup the 401k for the business that is currently making money (from which we are paying ourselves), e.g. the LLC, WHEN there are 2 of us?

-- How does this work with individual 401ks when there are two ppl full time?

-- Implication: 401k setup under E-IN

OR Do I setup a 401k for myself as a "sole proprietor" (e.g. my "revenue" is my income and my "business expenses" are my home office), and I'm the only one on the plan?

-- Implication: 401k setup under SSN

401k under EIN will mean that you'll both need to be in the 401k. The main complication there is if one person wants different profit sharing % than the other person. In that case, you'll need custom plan documents which can be more expensive.

I'm not sure that setting up the 401k under your SSN if you are in a partnership is legal/legit. First of all, I believe most if not all custodians will require an EIN and not a SSN. Second, you are a partnership not a sole prop so you wouldn't normally be able to use an SSN anyway. This is to make sure everything is done at the business level so you don't leave out employees. While your custodian (if they accept SSN) might not look too closely, there could be tax issues down the road if you are audited. One risk that would worry me is that the contributions could be disallowed and then you'd owe a lot of taxes and penalties and lose out on the tax sheltered space.

[thef0x]

Question:

Do I setup the 401k for the business that is currently making money (from which we are paying ourselves), e.g. the LLC, WHEN there are 2 of us?

-- How does this work with individual 401ks when there are two ppl full time?

-- Implication: 401k setup under E-IN

OR Do I setup a 401k for myself as a "sole proprietor" (e.g. my "revenue" is my income and my "business expenses" are my home office), and I'm the only one on the plan?

-- Implication: 401k setup under SSN

401k under EIN will mean that you'll both need to be in the 401k. The main complication there is if one person wants different profit sharing % than the other person. In that case, you'll need custom plan documents which can be more expensive.

I'm not sure that setting up the 401k under your SSN if you are in a partnership is legal/legit. First of all, I believe most if not all custodians will require an EIN and not a SSN. Second, you are a partnership not a sole prop so you wouldn't normally be able to use an SSN anyway. This is to make sure everything is done at the business level so you don't leave out employees. While your custodian (if they accept SSN) might not look too closely, there could be tax issues down the road if you are audited. One risk that would worry me is that the contributions could be disallowed and then you'd owe a lot of taxes and penalties and lose out on the tax sheltered space.

Wonderful information.

So even though it's called an 'individual 401k',  we can establish one under our LLC for the two of us just as long as all our contributions match exactly.  Correct?  (This is what I assumed from my research but also saw cases where you had to be an individual or individual w/ spouse). 

Meaning we setup an individual 401k for our LLC, and have it pay us each $8000 directly into that 401k account (e.g. all of our earned income).  That $8000 would be an employer contribution with a $0 employee contribution.  And we wouldn't be taxed on that $8000. 

Correct? 

Thank you all for your replies -- I'm so green here and really do NOT want to mess this up!

[Vilgan]

Wonderful information.

So even though it's called an 'individual 401k',  we can establish one under our LLC for the two of us just as long as all our contributions match exactly.  Correct?  (This is what I assumed from my research but also saw cases where you had to be an individual or individual w/ spouse). 

Meaning we setup an individual 401k for our LLC, and have it pay us each $8000 directly into that 401k account (e.g. all of our earned income).  That $8000 would be an employer contribution with a $0 employee contribution.  And we wouldn't be taxed on that $8000. 

Correct? 

Thank you all for your replies -- I'm so green here and really do NOT want to mess this up!

Yes. You can establish an 'individual' 401k even though its a partnership. The key thing is that you can't have any regular employees, everyone in the business needs to be a part owner.

Your contributions to profit sharing need to be an equal % for the free plans. You can also do regular employee deferrals (the 18k limit stuff) and each person can make their mind up about that.

If your entire income is 8k, you won't be able to contribute that entire amount. Profit sharing is capped at 25%. Also, there's some SE tax that happens somewhere in that process as well (I'm not as familiar with those details as I haven't gone through that process yet). If your income is 50k each, then you can easily put in 8k per person (assuming you are splitting profit 50/50) into profit sharing.

I would highly recommend looking up the fidelity self employed 401k or Vanguard equivalent and also calling them to ask questions. Fidelity has been very knowledgeable and helpful in my experience and presumably Vanguard would be as well. I went with Fidelity because Vanguard solo 401k plans don't allow access to Admiral funds so Fidelity actually ended up being cheaper and I also find their website/customer service to be far superior.

[Reynold]

Tax deductions:  if I am paying for them on my personal card, can I still file them as deductions?  Or do I file those deductions as self-employment deductions?  Do I file tax deductions via the business or my individual taxes?

First of all, don't do this!  Pay for business expenses on a personal card, that is, you want to keep business income and expenses separate from personal, so have a business card, business bank account, etc.  Not only does this help if you get audited, but it also avoids "piercing the corporate veil".  If someone sues you for something business related, and you were mixing personal and business expenses, they may be able to come after personal assets too.  One big reason behind setting up a LLC is to separate the business liability from personal. 

Regarding deductions, take anything business related from business income first.  After NET business income is calculated for the year, a schedule K-1 is generated (assuming you are in the USA?) which shows business income for you, which then adds onto any personal income and you pay taxes on that.  Personal deductions have a lot more restrictions in general. 

When my partner and I set up our side business, we hunted for a lawyer and an accountant who were willing to give us some guidance on how to categorize things and how the tax flow would work.  I learned enough that now we do our own accounting and taxes, but we have a very simple business and it is still a bit confusing at times to get the tax forms to reconcile.