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Best Tax Strategies for Self Employed - Keep More of What You Earn! - YouTube
Channel: Toby Mathis Esq. | Tax & Asset Protection
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- Hey, guys, Toby Mathis here
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with Anderson Business Advisors.
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A question we get a lot
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and something that I
want to address today,
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are the best strategies
for the self-employed.
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So, first off,
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if you are self-employed,
understand that if you do nothing,
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there is a default designation
for that type of income,
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let's say you're 1099,
you're making money,
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you're running your own a plumbing company
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and you're making money.
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All of that's going to end up
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on what's called a Sole
Proprietor Schedule C.
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That's the default.
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The default is,
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all of that money is going to be subject
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to something called social
security or self-employment tax.
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In fact, you're going to have to file
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a form SE for self-employment tax.
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That is old age, disability,
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and survivor's insurance, and Medicare.
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It adds up to 15.3% on every dollar,
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it phases out on a portion of it,
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the OADSI, the old age,
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disability, and survivor's insurance
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is going to phase out at about $140,000.
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And it might be coming back,
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depending on what the Biden
administration does at $400,000.
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But it phases out for the most part
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and then you have
Medicare going on for 2.9,
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continuing on per infinity on that one,
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on every dollar you make.
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Now here's the downside
of just doing the default,
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you're responsible personally
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on any debts and liabilities
of that business,
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and your business is
personally responsibility
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for anything you do.
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There's no distinguishing
between you and your business
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if you just do the default.
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If you want to create
a liability structure,
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you could set up an
LLC that is disregarded
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for tax purposes.
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You still file on your Schedule C,
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but at least the
liabilities of the business
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remain the liabilities of the business,
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and you, your personal
liabilities are not,
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you know, do not flow into the business.
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The business would be separate.
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Now, I still think that there's
a bigger issue out there,
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which is the tax issue.
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And from my standpoint,
I'm a tax attorney,
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I see this all the time.
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The biggest thing is how much do I make
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and how much do I keep?
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If I make $100,000, how do I set things up
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to where I keep the
biggest proportion of that
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that I can actually spend.
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When I am a sole proprietor,
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100% of that money is subject
to the self-employment tax,
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100% of that money is subject
to federal income taxes
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and state income taxes,
depending on my state.
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If I do a simple change
of designation and I say,
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no longer do I want it to
be treated for tax purposes
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as a sole proprietorship,
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I would like it to be
treated as an S corp instead,
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even if it's an LLC,
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I can still make this
election with a one-page.
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Magically, only the salary I'd take,
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I become an employee of an organization
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instead of a sole proprietor,
and I can take a salary,
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and that salary portion is the only thing
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that's subject to the self-employment tax.
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The rest of the profits
are no longer subject
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to the OADSI or Medicare.
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It is like a magic wand
and you get to keep
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an extra 14% of the money, it's 15.3%,
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but there's a deduction
for half and ends up being
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about 14% on $100,000.
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So if I let's just say
that I take a small salary,
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I could be saving myself
close to $10,000 a year
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just by making that designation.
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Ooh, that's strategy number one.
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Do not operate as a sole
proprietor if you're making,
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I'm just going to use a rule of thumb,
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more than $30,000 a year.
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Number two, if you're
going to be self-employed,
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become an employee and
use an accountable plan,
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it allows you to reimburse
100% of the expenses
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that are for the benefit
of that organization,
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the organization being your S corp
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or your LLC taxed as an S corp.
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What does this mean in English?
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It's just like you're
working for somebody else
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and they say, you need
to have a home office.
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If I am the proprietor, I have
to do this special document
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and I'm greatly diminished in my ability
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to take a deduction.
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If I do take the deduction,
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I have something called
depreciation recapture
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that I have to worry about,
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depending on the size of the office,
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whether it's attached to my home,
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if it's a secondary unit like a garage,
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or a caseta, or something like that,
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it triggers a whole bunch of weird stuff.
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And I get a very small
amount of deduction.
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If I am an employee, the
company can reimburse me
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whatever percentage of
my net square footage
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or however many rooms I have,
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I can use a room method and reimburse
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whatever proportionality
my house is being used,
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and I don't have to
worry about depreciation,
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and I don't have to report it anywhere.
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I ended up getting a much
more significant deduction
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as a result, a lot more
money that comes off the top,
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and I'm not going to have to pay tax on,
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or self-employment tax on.
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It ends up being a huge win.
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We see that it's about 6 to 10 times
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as much of a deduction using
the reimbursement method,
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versus the home office method.
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So it's much better to be an
employee of an organization.
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I don't have to worry about which portion
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was used for business and which portion
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is used for personal if
I am being reimbursed
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from my employer organization,
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the S corp, for the
employer to use like things
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like cell phone, my data plan,
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even portions of my internet,
even portions of my home,
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representing portions
of my real estate tax,
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that maybe be maybe phased
out from the SALT deduction,
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state and local taxes,
maybe there's a cap on it.
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And if I'm not getting
to take the full amount,
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then this is another
benefit that comes out
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is that I can reimburse the
portion of the business,
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that percentage, let's say I'm using 25%
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of the net usable square
footage as a big office,
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I can reimburse 25% of
even my real estate taxes,
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my internet, even the maid,
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if I have a maid or a
house cleaner that comes in
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and cleans up my house,
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all those things become reimbursable,
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that employer's portion.
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I don't have to report it anywhere
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and the business gets to write it off,
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that's a huge benefit.
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The other benefit is if you
start looking at the IRS
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and how they like to view your activities
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as a sole proprietor versus an S corp.
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And here's a secret, your
chances of being audited
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as a sole proprietor
are about 800% higher,
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if you're making $100,000 a
year, it's 1.6% audit rate,
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your chances of winning are about 5%
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if you're a sole proprietor.
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In other words, you will lose
94-95% of the time on average,
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according to the IRS data book,
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which is not a good winning percentage.
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If you are an S corp,
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your audit rate is 0.2% instead of 1.6,
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so it's an 800% difference,
or eight times difference,
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however you want to look at it,
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and your chance of winning
goes from 5% to about 30%.
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So it jumps up 600%.
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But the biggest benefit is
that you're going to pay
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about $10,000 a year less in taxes,
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just on that self-employment tax.
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Plus, you're going to get
all these other benefits.
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That's a huge one.
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So the audit rate is significantly higher,
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your losing rate is
significantly higher when you are
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a sole proprietor, and you
have to pay more in taxes.
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It's like a triple whack, right?
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We don't like that, no,
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we don't like the sole proprietor,
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we want to be an S corp
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if we're making that type of money.
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Again, the magic line
where it really starts
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to benefit you is right around 30,000.
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In fact, just doing straight
apples to oranges comparison
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from a tax saving standpoint,
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it's about $1,500 on the first 25,000.
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So there's a little bit of
added expense of the S corp,
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meaning that you have a tax form,
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which you still have to
do the Schedule C anyway,
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but technically you have
to do an extra tax return.
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So let's just pretend like
that's really that, you know,
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even though we have to
do it as an individual,
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let's just pretend it's more.
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We have to set up a organization,
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so we're going to be setting
up an LLC or a corporation,
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whatever that might be.
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I'm going to say $1,500
a year being the S corp,
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even at 25,000,
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it's going to pretty
much offset any expense
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or hassle factor that comes along with it
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at right around 30,000, like 25,000,
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it makes sense for most
people, even at 20,000,
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it may make sense.
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But the push is, that's just the tax,
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the asset protection side of it.
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Like let's say I decide to
open up a plumbing company,
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even if it's only making $10,000 a year,
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my liability is unlimited.
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If I go in and I flood
out somebody's basement,
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if I don't set up the
business structure anyway,
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I'm personally liable on that.
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They could sue me and follow me around
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until my dying days, garnishing
anything I ever make.
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So I want to make sure I had that set up,
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from a business standpoint I
want to have the structure,
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from a tax standpoint,
I get this huge savings.
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And then the other benefit of operating as
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a business period is
putting together that 401k
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and attaching to it, so
I could defer the taxes
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on the revenue that I'm making.
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So if I make money and let's just say,
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I'm making $100,000 again,
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I'm paying myself, let's
say $30,000 a year in wages,
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I could defer the first 19,500
if I'm under a 50 years old,
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if I'm over 50, I get a
make-up of an additional 6,500,
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but I get to defer that
immediately in a 401k.
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Plus, 25% of whatever I get paid in wages.
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So in this case,
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25% of 30 is what, 7,500?
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The company can put 7,500 into
my retirement plan as well.
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So there's this added benefit,
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I could be really putting in more money,
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let's say I'm over 50,
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I could put away more than $30,000
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off of taking a $30,000 salary.
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So I could defer more than what
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I'm actually taking into a 401k.
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And that if your mind just exploded,
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that's a good thing, because
that's a huge benefit,
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that's how powerful it is.
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Now, I still have the rest of the profit
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that's flowing down
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and I do have to pay
the self-employment tax,
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even if I'm deferring employee wages,
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I still have to pay the
self-employment tax.
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The employment taxes on that first,
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social security taxes, there we go,
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on that first 30,000, I'm
still paying it no matter,
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even if I'm putting in a 401k.
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But then that other $7,500
I'm not worrying about.
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That profit that flows down,
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whatever after those deductions.
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So in this case, I just
put $30,000 in wage,
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7,500, so that whatever
the 37, 500 minus 100,
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whatever that is, I'm
gonna pay tax on that,
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it's gonna flow down to my return.
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I still get my standard
deduction, which this year is,
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let's say it's 24,800 for my family.
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I get a standard deduction as well,
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so next thing I know I'm
not really paying much
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in taxes at all running this business,
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as opposed to, if I just
let the a hundred hit me,
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I'm going to have some tax on it,
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I'm probably going to be
paying close to 25-30%.
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So I'm really going to lower
my tax bill significantly
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if I'm doing this, running
it as a S corporation
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from a tax standpoint and using
a 401k, they're so potent.
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Yes, it's in a 401k,
yes, it's deferred taxes.
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I can continue to invest that,
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no, I can't just take it and spend it.
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If I'm in an emergency, I
can still access that money.
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If I'm smart, I might
borrow half of it back out
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over a five-year period
at federal AFR rates,
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which are really, really low.
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I could still do that.
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There's like all sorts of
reasons why you use that 401k,
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but on an annual basis,
it's going to save you,
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again, thousands of dollars.
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And when we start adding
up how much tax savings,
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on an annual basis by using
the S corp and the 401k,
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we're generally going to be looking
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at least 15 to $20,000 a
year, which is a lot per year.
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That's like, again,
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that's like making an extra 20%,
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that's a really good return just by filing
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a tax designation and
using a retirement plan.
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Those are the tax benefits for setting up
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and operating as a self-employed person
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as opposed to just W2, you're kind of
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at the mercy of wherever you're working,
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and you're at the mercy of whether
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or not there's a 401k, and
how much I can contribute,
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and is there a match and all those things.
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But when I'm self-employed,
I am in control baby,
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and I can absolutely take
advantage of these things
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and I can choose what's
in my best interest,
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and you can get a ton
of benefit out of it.
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So that's the best way
I'm going to make sure
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that I'm getting it.
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Those are the best tax
strategies for the self-employed.
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The best strategies period,
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is making sure that I'm
doing an accountable plan,
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making sure I'm doing the
employee reimbursements,
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make sure I'm making it an
S corporation at a minimum,
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we didn't get into the C corp,
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but I'm just going to say
where you're starting off is
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always going to be the S,
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we may be looking at something different
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depending on your scenario.
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And because there is no one size fits all,
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we do want to make sure that we're talking
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to you about your facts and circumstances.
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If you have a spouse that's
making a ton of money
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on the side, for example,
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or if you have carry forward losses,
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all these things have to be factored in.
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But those are the big benefits
of running your own business
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is you get the business deductions,
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you get the reimbursements,
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and you get the retirement
plans as a result.
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You can always protect your
liability just by putting it
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in an LLC or a corporation and isolating
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the business activities
from your personal,
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and it absolutely works
to your best interest.
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Give us a buzz if you
want to talk to somebody
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about your facts and circumstances,
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to make sure that what appropriate
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and you get an idea of
what the pros and cons
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are of anything that's available out there
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so you can start bouncing it around
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to see what's in your best interest.
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We're more than happy to do it,
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and then you could take advantage
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of all those benefits as well.
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