Author Topic: Side hustle getting big - which business structure? & Sales/Service tax question  (Read 3114 times)

Smokystache

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Summary: Side business is taking off and I am getting close to finalizing a deal with big corporation. I’m currently a sole proprietorship and need to know how to structure my business for legal and tax purposes. I also have a convoluted sales process and I’m not sure what taxes need to be charged/paid.

My side Business: I provide a wide variety of printed products (books, booklets, etc.), written content, workshops, presentations, consulting services. My area is psychology, so the content is related to mental health. My printed materials include the disclaimer “this is not a substitute for medical or psychological advice …” – but I do NOT provide individual or group therapy.

I do 90% of the work on this business currently, but my spouse does help (married, if that makes a difference for tax, business structure purposes). Currently we have our net income from side-business taxed as self-employment income.

Current income
: sole proprietorship (net pre-tax revenue ~$25,000/year)
Future income: Based on a deal that will finalize this summer, side business income will likely work up to approximately $130,000+ net pre-tax revenue over the next 18-24 months (could go above $200k within 2 years). The bump in income will mostly come from a single service – described below. The bump in income will also require that my married spouse helps more.

Question #1
How should I structure my business for maximum tax saving and other purposes?

Other factors
: A big part of my side business is literally stuffing envelopes (see “New Income/Project” below for details). On any given week or month, me or my spouse could do 90/10% or 10/90% of the work. Just depends on who has the free time besides my regular job and parenting kids to do the work. Also – my children can work on the business – they can pull the strip off of an envelope and seal it just as well as I can or put stamps on envelopes. I think there is a lot of flexibility to genuinely having my spouse and children work within the business. As my children become teens and this expands, I’d love to have this be their part-time job and then use their earned income to start Roths really early. My spouse and I don’t care who gets paid exactly what, but of course we would want to take advantage of all the possible, legal tax avoidance that we can.

I currently have a full-time job with benefits – I will likely quit within 2 years to focus on the side-business. My wife does not work outside the side-based business. What tax/company structure would be best?

Bonus question: would the answer above be the same if the business grows large enough that I’d need to hire a part-time employee? That employee might be a brother, older parent (someone from outside of our household).

I’m assuming I need to get some business-related insurance – what kind specifically?
Is this a situation where an S-Corp may be useful?


Details for Question #2 below
What should I charge/pay in sales/service tax?

New income/project: The bump in income is primarily coming from one contract with two larger companies and all three of use serve a specific type of business.


Field/Business: Mortgages/Mortgage Brokers (This is not the actual field, but the structure products are the same. 

Players: (each a stand alone company)
1) Megacorp: big company worth over $1 billion that services loans and wants to be the preferred provider that mortgage brokers eventually sell the mortgages to. Like a Citimortgage or similar company.
2) MortgageMarketing: company that helps mortgage broker offices with their marketing (social media, newsletters, etc. (approx.. $5 million in revenue a year). Mortgage Marketing has a database that can keep track of names, contact information and dates about when specific cards should be sent out.
3) Smokeystache Services: That’s me. In this situation I’ve created a set of reminder, holiday, and information cards that mortgage brokers/offices send out to the families they’ve served. Like “It’s been 6 months – hope you love your new home!” “Hey rates are lowest ever, need to refinance?” “Happy Holidays!” You know, the ones you throw out right away and hate to get.  I am connected to Mortgage Marketing’s database to tell me who to send which cards to at the right date.

Here’s how it works. Megacorp approaches mortgage brokers’ office they already work with and say “We can set you up with this great reminder/informational card system.” Broker’s office says yes- that sounds like good marketing. Brokers office pays Megacorp for a set number of “contacts” to be mailed. Broker’s office sends names/addresses of people they want contacted to Mortgage Marketing; they put names into database. Smokeystache Services (My spouse and I) looks at the database a couple of times a week and orders the right cards, buys the envelopes, stamps, etc and mails the cards to the contacts on the prescribed timeline. Megacorp keeps 10% for themselves, sends 10% to Mortgage Marketing for maintaining database, and sends 80% to Smokeystache. I pay for stamps, cards, envelopes out of that 80% and keep the remainder for profit. 

Question #2. What sales tax should be paid in this transaction? My primary expenses are the cards (printed out of state), envelopes (purchased from MegaEnvelope – out of state), and first-class stamps (purchased tax free b/c stamps aren’t taxed). Should I be charging Megacorp any type of tax? Or is paying tax on my profits based on whatever business structure I have my only tax in this situation. I’m in Tennessee if that matters. 

I’m assuming some of you would say that I should voluntarily pay state sales tax for the cards and envelopes to the various states where those businesses are located. Should I?

CareCPA

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For Question 1, with the info given, I would probably suggest an S Corp (specifically, probably an LLC tax as S Corp). If your business isn't large enough the first year to make the S election worth the extra filing, then you can just wait to make the election until it makes sense. With the caveat, as SeattleCPA would say, that an S corp tax return is not a DIY return.

The benefit of the S corp is that you can pay yourself a reasonable wage, and take any additional money out as distributions. You are taxed on the income when you earn it in the business, but S Corp income is not subject to self-employment tax.

So say you gross $130K in 2018. Say 70% of your job is stuffing envelopes, and 30% is skilled (i.e. marketing, advertising, CEO meetings, etc). You could probably justify something close to minimum wage for envelope stuffing, and something higher for the skilled part. If you worked full time, this might look something like: (18k*70% + 50k*30%) = $27,600 in wages. That means ($130k - $27.6k - operating expenses) would be available for distribution, subject to income tax in the year earned, but not subject to self-employment tax and available for distribution to you at any time.
(note, the above is just an example, and you should do research into what would be considered a reasonable salary for your area and job description).

ETA: having your children work is the business is a great way to shelter an extra ~6k per child in taxes, and a great way to fund retirement accounts for them early on to get the compounding started.
« Last Edit: May 06, 2017, 10:37:05 AM by FrugalGrad »

GetSmart

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I believe in this situation you would be considered a re-seller and therefore would not pay sales tax on printing, envelopes, etc.  You should check with your state about getting a tax-exempt certificate.  I also don't think you'd charge your clients sales tax on the product as it's a service, but not sure about that.

Smokystache

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For Question 1, with the info given, I would probably suggest an S Corp (specifically, probably an LLC tax as S Corp). If your business isn't large enough the first year to make the S election worth the extra filing, then you can just wait to make the election until it makes sense. With the caveat, as SeattleCPA would say, that an S corp tax return is not a DIY return.
...

So say you gross $130K in 2018. Say 70% of your job is stuffing envelopes, and 30% is skilled (i.e. marketing, advertising, CEO meetings, etc). You could probably justify something close to minimum wage for envelope stuffing, and something higher for the skilled part. If you worked full time, this might look something like: (18k*70% + 50k*30%) = $27,600 in wages. That means ($130k - $27.6k - operating expenses) would be available for distribution, subject to income tax in the year earned, but not subject to self-employment tax and available for distribution to you at any time....

I hadn't even thought about the fact that certain aspects of the job that require less skilled labor could be calculated at a lower hourly rate. That makes a lot of sense (and could save me a boatload of taxes). But you're exactly right - if I were to hire out the stuffing of envelopes, I certainly wouldn't pay them the same as my consulting rate.

Quote
ETA: having your children work is the business is a great way to shelter an extra ~6k per child in taxes, and a great way to fund retirement accounts for them early on to get the compounding started.

Is this because each person (even children <18) would have their first 6k be totally exempt or something?

Would I be allowed to set up a retirement plan for the company even if all the employees are family members? I'd be happy to set up a 401k or similar plan and make it available to me, my spouse, and my children - if that is possible.


CareCPA

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I hadn't even thought about the fact that certain aspects of the job that require less skilled labor could be calculated at a lower hourly rate...
Many people don't, and miss out on a great opportunity

Is this because each person (even children <18) would have their first 6k be totally exempt or something?

Would I be allowed to set up a retirement plan for the company even if all the employees are family members? I'd be happy to set up a 401k or similar plan and make it available to me, my spouse, and my children - if that is possible.

Even if you claim your kid as a dependent, they can still file on their own and take advantage of the standard deduction (which was $6,300 for single for 2016). You can set up a retirement plan, although I am not an expert in them so you should consult someone who is to see which would be best for your situation.

SeattleCPA

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Agree with the comments and ideas expressed thus far in the thread, but to try to add to the discussion, two other ideas...

1. It'd be important to know what OP's other wages income is... i.e., if already close to or over the FICA limit, that probably limits FICA savings from an S corporation because OP will probably have to pay some shareholder-employee wages even if other wages just to make the S corporation tax return "look" right.

2. In this business (with the printed materials), there is opportunity for Sec. 199 DPAD deduction and that could be meaningful if forecasted profit numbers are achieved. The thing with DPAD is you need wages in order to get the deduction to work... and an S corporation creates wages. More info here:

http://evergreensmallbusiness.com/qdpad-a-big-deduction-for-some-small-businesses/

Smokystache

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Agree with the comments and ideas expressed thus far in the thread, but to try to add to the discussion, two other ideas...

1. It'd be important to know what OP's other wages income is... i.e., if already close to or over the FICA limit, that probably limits FICA savings from an S corporation because OP will probably have to pay some shareholder-employee wages even if other wages just to make the S corporation tax return "look" right.

I currently make about $60k pre-tax closer to $40k AGI from my day (W-2) job. However, I'll quite this job when my side business grows to 100k+. I expect there will be a period of overlap when I'm making double my current salary - but that would be short-lived (no more than one year).

Quote
2. In this business (with the printed materials), there is opportunity for Sec. 199 DPAD deduction and that could be meaningful if forecasted profit numbers are achieved. The thing with DPAD is you need wages in order to get the deduction to work... and an S corporation creates wages. More info here:

http://evergreensmallbusiness.com/qdpad-a-big-deduction-for-some-small-businesses/

Holy crap. Never heard of that. So a substantial portion of my side business is selling cards and booklets. I have authored/created these items and then have them printed in the US by a professional printer. I suspect that within 1-2 years that I will have annual printing costs (booklets & cards) of ~$60k. So it qualifies even though someone else is doing the actual printing? In every other way, I've created (written & designed) them. Heck, my name is on them.

So if my estimate of $60k in printing costs were true, I would be able to deduct 9% ($5400) as long as I have employees (S corp with at least myself as an employee?) and I paid my employees a total of at least $10,800.

Or another example, if my printing costs were $100k, I could deduct $9000 as long as I payed employees a total of $18,000? And this is after/in addition to deducting the printing costs from my gross profits as an expense??

Questions:
- Can I include shipping costs from the printer to me? Can I include shipping costs directly to my customers?
- Is the deduction based on my costs to have the product created OR my total costs to deliver that product to my customer? In my situation, would that include the cost of mailing my products (especially the cards) to my customers? This is an important point for me, because sending cards (stamps) is almost 50% of my total costs.

Thanks! Always amazes me to think that a thread could save someone 10s or 100s of thousands of dollars over time.

SeattleCPA

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So given your wages numbers you probably can't save that much payroll tax while you're still working by using an S corporation. At least that's my opinion because I think you're basically going to need to ignore your first job's wages when you set your S corp's wages.

But once you move to full time employment with the business, an S corporation probably makes sense. You might for example, pay yourself $40K in wages and than have say another $60K in profits... the s corp approach will save you maybe $9K in payroll taxes with these numbers.... and then the DPAD deduction would be roughly $5K (so that'll save you a little bit too... maybe $1K to $2K a year?)

This is not a DIY project. Find a good local tax accountant.

And then this caveat: My numbers here are rough and written to make them understandable... please don't take them as precise estimates of an appropriate reasonable compensation value or as specific tax advice.

P.S. Pre-s corp, you probably want to use a SEP... and then you possibly want to look at employing minor children of yours if you can create real jobs for them: http://evergreensmallbusiness.com/hiring-your-children-as-a-tax-loophole/

CareCPA

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Would the OP get the DPAD even though he isn't doing the actual printing? I would think the printer would get the deduction, and it would surprise me if the OP could also take it - the IRS often frowns on two parties getting the same benefit.
Note: this is not something I have researched in detail, I'm genuinely curious.

SeattleCPA

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Would the OP get the DPAD even though he isn't doing the actual printing? I would think the printer would get the deduction, and it would surprise me if the OP could also take it - the IRS often frowns on two parties getting the same benefit.
Note: this is not something I have researched in detail, I'm genuinely curious.

Great question. And I think the regs answer this question pretty clearly... the OP needs to be doing something substantial. Not minor assembly etc.

So with book publishing, if you have a printer printing... but you have the publisher writing, editing, compositing, etc., the publisher is a manufacturer.

OP would need to make sure his or her efforts were not minor and inconsequential... but the writing and editing and page layout could be pretty substantial.

BTW, ebooks don't qualify for DPAD. Which is kind of crazy given the writing, editing, compositing etc that occurs there.

Smokystache

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Would the OP get the DPAD even though he isn't doing the actual printing? I would think the printer would get the deduction, and it would surprise me if the OP could also take it - the IRS often frowns on two parties getting the same benefit.
Note: this is not something I have researched in detail, I'm genuinely curious.

Great question. And I think the regs answer this question pretty clearly... the OP needs to be doing something substantial. Not minor assembly etc.

So with book publishing, if you have a printer printing... but you have the publisher writing, editing, compositing, etc., the publisher is a manufacturer.

OP would need to make sure his or her efforts were not minor and inconsequential... but the writing and editing and page layout could be pretty substantial.

BTW, ebooks don't qualify for DPAD. Which is kind of crazy given the writing, editing, compositing etc that occurs there.

At first I thought this was a case of whether or not the deduction applied to the creation of ebooks, but my uneducated reading suggests that even if I am the author, I cannot claim the deduction if someone else does the printing: https://www.irs.gov/pub/irs-wd/1313020.pdf.

Hmm. But then the Suzy's Zoo situation here suggests that if someone else prints your greeting cards, and can't sell them to someone else, then you're good??   http://www.ipbtax.com/publications-13.html


 

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