S-Corp for lower income independent contractor?

[El TD]

Hello Fellow Mustachians,
I recently was offered a contract position for work-from-home website management. I am trying to figure out what is the best way to lower my taxes and maximize my savings. I've read a few of the other threads about incorporating for contractors, but I feel like they are assuming a pretty high level of earnings. As I will be managing content on a website for one client, I don't think I need to incorporate for the protection of my assets. (I've also heard that it's easy enough to "pierce the corporate veil" unless one is very careful.)
 
Here's my situation. I will be making 67K for the year from this contract. I file taxes as joint-married and our combined gross income (not AGI, just adding our two salaries together) is around 137K. We both have Roth IRAs and my wife has a 401K.

So, is forming an S-Corporation worth it? Is an LLC that elects to file as an S-Corp any better? Or should I bother to incorporate at all, i.e. just be an independent contractor?

I'm not exactly sure how to calculate my savings and taxes with the different options. On a basic level, paying the self-employment tax (15.3%) on 67K works out to $10,251. But paying myself $35K in wages would reduce that to $5355. What I don't know is if that's the end of the story. How much will I be taxed on the $32K in dividends that I would also give myself? How much does it matter that I will be filing jointly with my wife? What about further reducing my taxable income by providing myself benefits? (And I'm not sure which benefits are allowable and most effective for reducing tax burden.) So, if someone could point me to a place with a calculator or a thorough guide for calculating the differences, I'd love to see it.

Thanks for your input!
- El TD

[Cpa Cat]

The deal with S-Corps is that officer/owners need to pay themselves a reasonable salary (on which they pay payroll taxes). After that, any excess can be distributed to the S-Corp owner without payroll taxes.

There's no strict definition for what a "reasonable salary" is, though. Since you're a solo-employee and you just got hired for $67k to do what you're going to do, it sounds like that's probably a good indication of what a reasonable salary is. That said, you'll find a lot of different opinions on the subject of reasonable salary.

In your scenario, if you were to determine that $35K was your reasonable salary, you would have $32k left in the corporation. From that, you will deduct the employer's payroll taxes and other costs (accounting, for example). You will also file payroll and UI reports.

Then whatever is left of your $32K will be distributed. Note that an S-Corp does not pay dividends (that's a C-corp thing). An S-Corp is a flow-through corporation. That $32k (minus expenses) will be taxed to you on your K-1 as ordinary income. The distribution is not generally a taxable event (you are taxed when income is earned, not when it's distributed). So the only thing you save with an S-Corp is the self-employment tax portion - never income taxes.

[Cpa Cat]

Also remember that for an S-Corp, the rules are stricter about separation between personal and business than they are with a Schedule C.

The S-Corp should be a fully separate entity - with a different bank account. It should reimburse you for expenses such as mileage and health insurance and other out-of-pocket expenses - just like if you worked for a real company.

A Schedule C is a lot less complicated. No separation is needed (though bookkeeping can often be easier with a separate bank account). Even with a separate bank account, it makes no difference to deductibility of expenses if they're paid through that bank account or your personal bank account/credit cards.

[krishnamba]

Think about how to make a sep ira or solo 401k with vanguard.
You can put away 18k + 20% of net income of your salary and not pay taxes on that money.

[El TD]

Interesting, CPA Cat. Some of what you're saying seems to go against some of what I've seen around the web.
In this article http://www.investopedia.com/articles/pf/08/incorporate-business.asp, it mentions both cash distributions and dividends from an S-corp. It also mentions S-Corps having shares. I would guess that shares can offer dividends. But, maybe they are mistaken or confusing distributions with dividends.

This article from the SBA https://www.sba.gov/blogs/should-my-company-be-llc-s-corp-or-both suggests that the benefits given to any S-corp shareholder with more than 2% of the shares are not deductible.

"Keep in mind that some benefits that shareholder/employees receive can be written off as business expenses. Nevertheless, if such an employee owns 2% or more shares, the benefits like health and life insurance are deemed taxable income."

So, health insurance is not a deductible business expense, but the solo 401K would be?

[dandarc]

http://www.irs.gov/uac/Newsroom/Dont-Miss-the-Health-Insurance-Deduction-if-Youre-Self-Employed

So, the business doesn't deduct the health insurance, but you do.  Really not a gotcha at all.

[Midwest]

Interesting, CPA Cat. Some of what you're saying seems to go against some of what I've seen around the web.
In this article http://www.investopedia.com/articles/pf/08/incorporate-business.asp, it mentions both cash distributions and dividends from an S-corp. It also mentions S-Corps having shares. I would guess that shares can offer dividends. But, maybe they are mistaken or confusing distributions with dividends.

This article from the SBA https://www.sba.gov/blogs/should-my-company-be-llc-s-corp-or-both suggests that the benefits given to any S-corp shareholder with more than 2% of the shares are not deductible.

"Keep in mind that some benefits that shareholder/employees receive can be written off as business expenses. Nevertheless, if such an employee owns 2% or more shares, the benefits like health and life insurance are deemed taxable income."

So, health insurance is not a deductible business expense, but the solo 401K would be?

S-Corps could potentially have dividends (prior C-corp or dividend in excess of basis), but generally won't.  For your purposes, it's safe to assume distributions won't be taxable.  I'm pretty sure that's what the prior poster was conveying to you.

Health insurance of 2% shareholder is deducted by the corp, included on the w-2, and then you receive a deduction on your return for self employed health insurance.  It's deductible, just in a more round about way.

LLC taxed as S or Corp taxed as S is a question for an attorney.  In my state, LLC taxed as S would be preferred.

On thing to think about, LLC (assuming one member) requires no payroll and no extra tax return.  Those 2 things eat into the savings.  You could do LLC until you are making decent money and then elect S-status.  If you pay reasonable comp and drive your income way down with a solo-k/retirement and expenses, S-Corp loses it's luster pretty quickly at lower income levels.

[Insanity]

From a CPA on a podcast, anything over like $40K should be an S Corp.  he gave out the tax savings for the client who runs the podcast. he claims the S corp tax savings last year were around $43K.  I believe the company eclipsed $2M in earnings during the year.  But don't quote me on that. 

I am a strict LLC.  Should probably be an S-Corp.  but oh well.  I don't make that much a year and if I did, then I would consider it charitable contributions ;)

[simplified]

You just need an LLC. There are no additional benefits to being an S-corp unless you plan to have multiple employees. I have an S-corp and regret it. More paperwork and more fees to the accountant.

[Roboturner]

krishnamba, could you elaborate a little, I recently set up a i401k as a sole proprietor, and am a little confused about if you can sock away 18k and 20% of the total or if its 20% AFTER the 18k

ie with simple numbers: make 100k, put 18k away is it 20% of 100k (20k) or 20% of 88k (100k-18k). Also do you pay the SE tax on the 100k or the net after 20% and 18k.

Any guidance would be appreciated - thanks

[dandarc]

krishnamba, could you elaborate a little, I recently set up a i401k as a sole proprietor, and am a little confused about if you can sock away 18k and 20% of the total or if its 20% AFTER the 18k

ie with simple numbers: make 100k, put 18k away is it 20% of 100k (20k) or 20% of 88k (100k-18k). Also do you pay the SE tax on the 100k or the net after 20% and 18k.

Any guidance would be appreciated - thanks

It is actually 20% of your Schedule C net income less 1/2 of self employment tax.  So in this example 18K + 20% * (100,000 - .5 * 100,000 * .9235 * .153) = 18000 + 18587.05 = 36587.05.  That formula only works if 92.35% of your income is below the Social Security Max, which in this case, it is.

http://www.irs.gov/uac/Newsroom/Dont-Miss-the-Health-Insurance-Deduction-if-Youre-Self-Employed

What I do is send in 18K + 18.5% throughout the year as money comes in, then come tax time, figure it to the penny and make a small contribution for the prior year to use up every bit of that space.

[El TD]

Thanks for that elaboration, dandarc. I was going to ask, too.
So, it seems that we're leaning towards LLC and electing to file as an S-Corp if it's necessary. As Midwest points out, I can drive down my income with my retirement account and expenses to the point where the extra hassle of the S-Corp won't be worth it.

[dandarc]

Ask yourself if you even need to be an LLC.  Nothing wrong with being a sole-proprietor.  Suppose the LLC adds a layer of "I am not an employee"-ness which might be important to your client though.

[El TD]

No, the client won't care. And I'm not concerned about liability issues. So, you're saying I should just remain a sole proprietor. I would still be able to set up a solo 401K and take that health insurance deduction, right?
(I am currently on my wife's HDHP through her employer, but we are having a kid this Fall. She'll be taking maternity leave for 6 months, which means we'll need health insurance for at least 3 months of that.)

[Midwest]

No, the client won't care. And I'm not concerned about liability issues. So, you're saying I should just remain a sole proprietor. I would still be able to set up a solo 401K and take that health insurance deduction, right?
(I am currently on my wife's HDHP through her employer, but we are having a kid this Fall. She'll be taking maternity leave for 6 months, which means we'll need health insurance for at least 3 months of that.)

LLC costs $125 in my state.  It's penny wise and pound foolish not to set one up if you are making any money at all. 

Clients don't care if you are an LLC or not, but if you get sued it's an inexpensive layer of additional protection.  In my locale, no additional forms beyond the initial set up and no additional taxes.

[Roboturner]

krishnamba, could you elaborate a little, I recently set up a i401k as a sole proprietor, and am a little confused about if you can sock away 18k and 20% of the total or if its 20% AFTER the 18k

ie with simple numbers: make 100k, put 18k away is it 20% of 100k (20k) or 20% of 88k (100k-18k). Also do you pay the SE tax on the 100k or the net after 20% and 18k.

Any guidance would be appreciated - thanks

It is actually 20% of your Schedule C net income less 1/2 of self employment tax.  So in this example 18K + 20% * (100,000 - .5 * 100,000 * .9235 * .153) = 18000 + 18587.05 = 36587.05.  That formula only works if 92.35% of your income is below the Social Security Max, which in this case, it is.


http://www.irs.gov/uac/Newsroom/Dont-Miss-the-Health-Insurance-Deduction-if-Youre-Self-Employed

What I do is send in 18K + 18.5% throughout the year as money comes in, then come tax time, figure it to the penny and make a small contribution for the prior year to use up every bit of that space.

Thank you, very helpful!