Thanks for all your awesome advice. Clarifications to questions below.
You are at the point where you need a good tax advisor to guide you through a tax minimization strategy.
Roger that, I have a CPA I have worked with for 20 years, we plan to meet on these issues. Now I can go to that meeting reasonably prepared.
1) You mentioned maxing out 401k's. What exactly do you mean by this? $18K each? Because that is the 401k limit but...
2) SEP IRAs, SIMPLE IRAs, KEOUGH, etc. can have a limit of up to $53K/person and you seriously need to figure that out quickly if you haven't opened these type of accounts. Some of them must be opened before 12/31 of the tax year.
I made the max $52k contribution last year from my LLC earnings, and I had planned to make the $53k contribution this year. Last year it was a SEP IRA that I had set up when I was 22, and I rolled it over into a solo 401k this year and changed from Fidelity to Vanguard. I had made some poor investment decisions early in my life and have started to fix those.
My wife currently has a SIMPLE IRA at a nonprofit where she works, which screws some things up for us. The SIMPLE IRA isn't tax deferred (over the income limit), and we couldn't contribute to a separate 401k for her because of it. She may leave that job and become a majority owner of the C corp, take a salary, and let us put money away for her, too. We are still working this out, also see below on the 25% contribution limit which Georgia noted.
3) How can I get in on this action? : )
Same thing as any Mustachian endeavor, work hard, get lucky, stay focused intensely for a few years and retire :). I'm in public sector consulting, I partnered with a few different companies last year to write proposal responses at-risk. I worked for free in exchange for a piece of the action if we won. So I ended up spending about 600 hours last year writing proposals while working full-time on some other 100% travel hourly deals, and a big one came in. It was about a year between writing the proposal and starting the project. Then I executed the "land and expand" strategy to expand my scope by adding employees with the prime contractor and taking a conservative margin, which is a win-win. There are some other details but the takeaway is I was in the right place at the right time, saw an opportunity, exploited it, and got lucky.
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So the C-Corp tax rates, in case you haven't looked them up yet, are quite high. $0-$50k=15%, 50-75k=25%, 75-100k=34%, 100-335k=39% and it stays in the 3x% range beyond that. So at 150K your C-Corp would pay $41,750 in federal taxes (28%).
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Well, crap! That definitely changes the split, but maybe not the strategy. Thanks for the advice on retained earnings, added to my list.
2 - Not sure what business you are in, but assuming you are a cash basis tax payer, pay upfront as much of your expenses as possible prior to 12.31, and collect your receivables after 12.31. There may be other strategies, but it really depends on the type of business.
Roger that, I have this locked down. My accounting is cash basis. I'm a consultant and make margin on services from employees that are bought from a staffing company. So I typically pay the November bill for their services in December, and I don't get November receivables until 1/7. This lets me push about 50k in revenue to the following year and realize about 30k in expenses in the current year. Net effect will be to push 50k into a final, retirement tax year. If I add more employees the effect of this gets progressively larger, which is exciting.
3 - You need to be in the 15% tax bracket for qualified dividends - you're not even close
I need some help on this. My understanding is that qualified dividends are taxed at either 0% (for people in the 15% tax bracket) or at the capital gains rate of 15% plus a 3.8% Net Investment Income Tax for a final rate of 18.8% for people above that. The dividends would have to be taxed at the corporate level first, and then they'd get the double taxation hit at 18.8%. Or, I could keep the money in the corporation until I retire, then distribute it as dividends at an amount that keeps me in the 15% bracket. In this case, I'd still have had to pay the corporate tax rate on it in the year it was earned.
So $300K total net income.
Pay a wage of $138K, grossed up for ER payroll taxes would equal $147K in corporate deductions.
Pay a SEP/SIMPLE contribution of $53K.
Leave $100K bottom line in C-Corp which would net $77,750 after tax.
if it's possible to add your wife as an employee, you could defer taxes on 70K (yours and hers) of business income just with the 401k setup.
This mix looks about right, but with a gross salary of 147k, how do I get around the 25% contribution limit to get to the 53k? I could also pay my wife, but I think this ends up costing us money because above 117k on one wage, we don't pay the SS tax. This gives me some numbers to play around with though.
take more vacations and work less to minimize excessive earnings that are taxed at greater than 50%
Yeah, you're not kidding! I first became aware of this issue earlier this week when I started running some projections on earnings to ensure my estimated tax payments were adequate, and realized how much awful stuff would happen if I hit the AMT. Once I saw how heavy the taxes were on additional earnings, I realized what a waste of time it would be to add more income.
Can your company create a defined benefit plan?
Thanks, adding that to my research list. That could be one way to siphon off earnings now that I wouldn't use until later, when my tax bracket would be a lot lower. I think this works kind of like an annuity, but I definitely need to look into this.
1) Any plans to sell the business? Have you considered the implications of a C-Corp to that?
I haven't, good point. I don't have any plans to sell, but I never say never. Will need to look into this. As a consulting business, the value of the corporation is in the employees (primarily myself) and our contracts, where I'm a named resource. So buying the business probably doesn't make much sense. Regardless, adding this to my things to consider.
2) How many employees? I see mention of a 401k, but a solo 401k if you and the wife both work for the company (and are the only employees) allows significant contributions after considering the employor match
No "official" employees, but we have three people generating revenue for the company on a regular basis. Me, plus two other full time guys that I have working W-2 for a staffing company that bills me.