Help me structure my new business for maximum tax & financial efficiency

[Smokystache]

(I realize there is a separate “case study” forum, but my situation deals with so many tax & legal issues, that I thought I’d get better advice here. I have no doubt I’m missing some big things and finding an accountant and/or attorney is in my future, but wanted to get some feedback and continue investigating options on my own before I take that step.)

This year I’m transitioning from being a w-2 employee to being a 1099 employee and my own business income. Here are some details and assumptions.

Currently:
- Married filing jointly
- business is sole proprietorship
- current side business income ~$25,000/year

Transitioning to:
- 1099 long-term arrangement making $30,000 plus possible commissions
- side business income low estimate = $70,000/year (possible this could go as high as $150,000/year within 2-3 years)

Side business products & services
- I write, print, sell, and mail printed materials. The sales are business-to-business, although I often send materials straight to my business customers’ customers. This isn’t my product, but it would be like if I created custom refrigerator calendars and sold them to real estate business and then mailed them out on behalf of the real estate agency directly to previous & likely customers.
- I also give presentations/workshops for businesses/organizations and provide consulting services.


Other considerations
- Married, with 3 children. My two older children (ages 7 &9) legitimately help with some work-related tasks. Much of my business involves mailing (will work up to about 1500 envelopes a week) and my children already seal the envelopes for me. As they get older, they will be able to stuff envelopes, affix stamps, and seal them. I currently pay them some cash (I currently have much lower volume) and its just fun money for them.

- My spouse has a similar advanced degree to mine, currently edits everything I write, helps with printing, mailing, etc. She also attends conventions with me and helps me make sales/take orders. The only thing that I do entirely on my own is the presentations.

- employer-based health insurance ends on 9/1/17

Tentative Plan
My plan is to incorporate as an S Corporation before 1/1/2019 with my spouse and I as the only two owners/shareholders. We’ll pay ourselves a reasonable wage and (if there is enough income for it to make sense. We’ll be buying health insurance through the Corporation.

I plan to create some type of retirement plan through the corporation.

I plan to hire my children as regular employees – I’m confident I can make the argument that they are providing “common, acceptable, helpful, and appropriate” work for the business.

We don’t currently plan to hire any outside employees. If we do, they would be extended family members (retired parents) who wouldn’t need health insurance or a retirement plan.

Questions:
1) Given that my children will be employees of an S-corp, I’ll need to deduct self-employed taxes for them – correct?

2) Obviously it helps with taxes to pay my children as much as possible (to an extent) – it sounds like they could earn up to $12,000 year each and not pay any additional income tax. Would it be unreasonable to pay them $11 or $12/hr, $15/hr ?? Sounds like some states (not mine) will have $11/hr be their minimum wage. I’ll need to keep careful records of regular payments for actual services.

3) My wife does not have a W-2 job and she can perform many of the job duties as well as I can. So we’re in a situation where we could structure how much time each of us spends working on the business ….For example, we could split the workload 50/50 OR she could entirely focus on raising our children and I be the only one who works on the business. Let’s assume that we decide to pay ourselves $70k from the side business – what is the differences/advantages (if any) to the following splits:
Me: $70k/spouse: $0
Me:  $50k/spouse: $20k
Me: $35k/spouse: $35k

(Let’s assume that I’ve already determined that the salary amount is reasonable for my time/skills). Does the breakdown between me and my spouse make any difference? And I recognize that the amount would need to be connected to actual time and/or expertise that my spouse and I are bringing to the business.

4) How should I structure the retirement plan through the corporation? What type of plan would be best?

5) What obvious things am I missing or what information would be useful to examine other options? 

Thanks!

[SeattleCPA]

You probably do want to operate an S corporation as soon as you start making a high five figure profit. Be careful though about jumping on the S corp thing before that. It's too expensive to play the game if you're still ramping up:

Should you use an S corporation for a part-time or sideline business

You need to watch out on your payroll stuff. You have to pay people who work in the business. But you in general want to pay wages as low as possible because of the 15%-ish payroll tax hit you take on every dollar of wages. I would think, therefore, you don't want to rush to pay a spouse or kids unless they truly work in the business.

The math, BTW, does not support putting people on the payroll so you can contribute to their retirement accounts.

BTW, employing kids legitimately before you incorporate saves money:

Hiring Minor Children as a Tax Loophole

Also, make sure you understand the new Sec. 199A deduction. That's only going to apply to the nonwages part of an S corporation's profits. So the general rule there is, the S corporation only makes sense if you're saving FICA:

S corporation salaries and the Pass-through Sec. 199A Deduction

[msmargarita]

If they don't have 40 Social Security credits earned at this point, it might make sense to pay a enough of a wage for your spouse to qualify for those credits each year, for both future Social Security and Medicare Part A premiums.  ($1,320 wages for one credit in 2018, max 4 credits per year)

[SeattleCPA]

If they don't have 40 Social Security credits earned at this point, it might make sense to pay a enough of a wage for your spouse to qualify for those credits each year, for both future Social Security and Medicare Part A premiums.  ($1,320 wages for one credit in 2018, max 4 credits per year)

But in the cost benefit calculation, one wants to remember the details of the benefit calculations...

E.g, spouse gets 50% of primary earners benefit if that's more. So it only makes sense to create wages if those wages push someone above that minimum.

Also, it doesn't apply to MsMargarita's point (which I agree with BTW) but more generally... one wants to know how the primary insurance amount formula works in general terms if one is trying to optimize SS benefits. For example, some people are paying taxes to get 90% of their income replaced by SS... some are paying same taxes to get 15% of their income replaced:

https://www.ssa.gov/oact/cola/piaformula.html

[Smokystache]

You probably do want to operate an S corporation as soon as you start making a high five figure profit. Be careful though about jumping on the S corp thing before that. It's too expensive to play the game if you're still ramping up:

Should you use an S corporation for a part-time or sideline business

You need to watch out on your payroll stuff. You have to pay people who work in the business. But you in general want to pay wages as low as possible because of the 15%-ish payroll tax hit you take on every dollar of wages. I would think, therefore, you don't want to rush to pay a spouse or kids unless they truly work in the business.

The math, BTW, does not support putting people on the payroll so you can contribute to their retirement accounts.

Thanks for chiming in SeattleCPA - I always read your comments & have spent some time on your website. I was so busy thinking about ways to spread the income around, that I forgot that the better option is to have less income altogether and (eventually) take advantage of the pass-through distribution.

So if my spouse provides some editing and minimal work related to the business, I simply don't pay her for that work. I pay myself the least amount that I can reasonably justify, and then take the rest as pass-through income??

BTW, employing kids legitimately before you incorporate saves money:

Hiring Minor Children as a Tax Loophole

Also, make sure you understand the new Sec. 199A deduction. That's only going to apply to the nonwages part of an S corporation's profits. So the general rule there is, the S corporation only makes sense if you're saving FICA:

S corporation salaries and the Pass-through Sec. 199A Deduction

How does this sound as a rough priority list (as the business gets more profitable).
1) Stay as a sole proprietorship for now
2) Hire children as reasonable (I like the idea of using some income to start Roths for them); being a sole proprietorship (SP), I don't need to pay FUTA or payroll taxes for my children as long as I'm an SP (?)
3) Don't hire spouse; assuming she doesn't contribute a significant number of hours/tasks to the SP
4) As net income from 1099 and side business gets to high 5-figures, look at moving to an S Corp
5) Once income is high enough, become an S Corp; pay myself a reasonable wage (but not more than that). If paying children, then would need to begin paying payroll taxes and PUTA taxes. But operating as an S corporation only makes sense if I can reasonably justify to teh IRS that my total net profit is significantly higher than a reasonable salary to myself (hence, saving the FICA on the difference)?

What am I misunderstanding?
Thanks again!

[SeattleCPA]

You probably do want to operate an S corporation as soon as you start making a high five figure profit. Be careful though about jumping on the S corp thing before that. It's too expensive to play the game if you're still ramping up:

Should you use an S corporation for a part-time or sideline business

You need to watch out on your payroll stuff. You have to pay people who work in the business. But you in general want to pay wages as low as possible because of the 15%-ish payroll tax hit you take on every dollar of wages. I would think, therefore, you don't want to rush to pay a spouse or kids unless they truly work in the business.

The math, BTW, does not support putting people on the payroll so you can contribute to their retirement accounts.

Thanks for chiming in SeattleCPA - I always read your comments & have spent some time on your website. I was so busy thinking about ways to spread the income around, that I forgot that the better option is to have less income altogether and (eventually) take advantage of the pass-through distribution.

So if my spouse provides some editing and minimal work related to the business, I simply don't pay her for that work. I pay myself the least amount that I can reasonably justify, and then take the rest as pass-through income??

BTW, employing kids legitimately before you incorporate saves money:

Hiring Minor Children as a Tax Loophole

Also, make sure you understand the new Sec. 199A deduction. That's only going to apply to the nonwages part of an S corporation's profits. So the general rule there is, the S corporation only makes sense if you're saving FICA:

S corporation salaries and the Pass-through Sec. 199A Deduction

How does this sound as a rough priority list (as the business gets more profitable).
1) Stay as a sole proprietorship for now
2) Hire children as reasonable (I like the idea of using some income to start Roths for them); being a sole proprietorship (SP), I don't need to pay FUTA or payroll taxes for my children as long as I'm an SP (?)
3) Don't hire spouse; assuming she doesn't contribute a significant number of hours/tasks to the SP
4) As net income from 1099 and side business gets to high 5-figures, look at moving to an S Corp
5) Once income is high enough, become an S Corp; pay myself a reasonable wage (but not more than that). If paying children, then would need to begin paying payroll taxes and PUTA taxes. But operating as an S corporation only makes sense if I can reasonably justify to teh IRS that my total net profit is significantly higher than a reasonable salary to myself (hence, saving the FICA on the difference)?

What am I misunderstanding?
Thanks again!

Smoky I think you got it. Your general roadmap is exactly right. Excellent summary.

[Smokystache]

Whew! Thanks so much!