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What is an LLC vs. S-Corp: Which is right for your small business? - YouTube
Channel: Tara Wagner Coaching
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What is an LLC versus an S Corp and why in聽
the world can no one explain it in layman's聽聽
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terms? We are gonna get really聽
technical in this video. So technical聽聽
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that I'm gonna have to refer to my notes because聽
I can even misexplain this. Misexplain? Is that聽聽
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a word? It's gonna be a word now. I can mess聽
this up if I don't actually explain it properly.聽
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There are a lot of things you need to understand,聽
to understand which one is right for you. It took聽聽
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me years to understand this and cost me tens of聽
thousands of dollars, because I didn't understand聽聽
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it. So although I am by no means your tax lawyer聽
or any sort of tax expert, let me explain this in聽聽
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a way that will actually make sense so that聽
you can understand for yourself, which is聽聽
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better for your business - an LLC or an S Corp.
I'm Tara Wagner, breakthrough coach and lifelong聽聽
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entrepreneur. I help other entrepreneurs聽
use a holistic approach to business聽聽
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so they can create profits they can depend聽
on without burning themselves out. If that聽聽
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sounds like your jam, be sure to check out聽
my free training on how you can do the same.聽
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This video has been sponsored by ClickUp. If聽
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All right, before we jump in, there are聽
two caveats that you must understand.聽
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Number one, always talk to your CPA or a tax聽
attorney when it comes to this stuff, because your聽聽
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business is unique and what you learn on a YouTube聽
video can be educational and it can be helpful,聽聽
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but only to get you to understand what you need to聽
understand so that when you go into those meetings聽聽
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with your professionals, you sound a little bit聽
more intelligent. That's really all it's about,聽聽
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but you must talk to somebody who can聽
look at the details of your business聽聽
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and really help you decide, which is聽
right for you, an LLC or an S Corp.聽
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Caveat number two, is that talking about聽
an LLC versus an S Corp is really apples聽聽
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to oranges because they are really different聽
things. So let me describe what an LLC is,聽聽
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what an S Corp is. and then through that, show you聽
how you can determine which one is best for you.聽
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And also let me add an extra caveat of saying聽
that this applies to people in the US with small聽聽
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businesses. So if you're not in the US, this聽
is probably not gonna make much sense for you,聽聽
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and you definitely need to learn what the聽
different options are for you in your country.聽
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What is an LLC?
First of all, what is an LLC? LLC stands for聽聽
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limited liability company. This is a legal or聽
business structure that just protects you and聽聽
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your personal assets. Which basically means if聽
your business is sued or you lose everything聽聽
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and go bankrupt, nobody can come after your聽
house, or your personal car, or your personal聽聽
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savings. It separates you from your business.
LLCs by themselves do not save you money on聽聽
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your taxes. A lot of people will say that and聽
they're completely misunderstanding what an LLC聽聽
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is. It can't save you money on your taxes because聽
it's not a tax classification. It's a business聽聽
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structure. A business structure just says聽
this is how I'm setting up my business.聽
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A tax classification tells the IRS how to tax that聽
business, but there are four different types of聽聽
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tax classifications that your LLC can have.
You can be set up as a sole proprietor聽
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A partnership
An S Corp聽
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A C Corp
S Corp is the聽聽
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one that we're gonna talk about in just a second.
Now, by default, the tax classification for an LLC聽聽
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is set up as sole proprietor, unless you set it up聽
otherwise. What this means is that on your taxes,聽聽
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all of your income, all of your business expenses聽
get reported on your personal tax return.聽聽
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And you're gonna pay your federal, your聽
state, and your self-employment taxes聽聽
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out of that personal tax return as well. You're聽
not gonna pay Medicare or social security taxes.聽
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Who should have an LLC?
Now who should have an LLC?聽
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Number one in any business that has聽
a higher likelihood of being sued.聽聽
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If you've got a lot of liability in your business,聽
it's good to set up an LLC because it limits the聽聽
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liability to the business so that people,聽
again, can't come after your personal assets聽聽
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if you go bankrupt, or if you get sued.
If you don't run a high risk business,聽聽
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you might still consider an LLC when you're聽
making enough money for the costs of your LLC聽聽
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to be covered by your profits. So in other words,聽
there's gonna be a cost for setup. There's gonna聽聽
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be yearly fees associated with it, usually from聽
your state. Mine are from my state, I'm assuming聽聽
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it's all states. You might also have CPA fees聽
for additional forms that have to be filled out聽聽
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when you're doing your tax returns.
So when should you set up an LLC,聽聽
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depending on your business, this might be from day聽
one, or it might be when you've got a couple extra聽聽
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thousand dollars in profit to be able to handle聽
any extra fees associated with running an LLC.聽
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Okay. So that is an LLC. If聽
that does not make sense,聽聽
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let me know in the comments and I will do my best聽
to answer your questions, but just know again,聽聽
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I'm not an expert. Get educated, but definitely聽
go and talk to your CPA or your tax attorney.聽
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What is an S Corp?
What is an S Corp though?聽聽
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First of all, you need to understand that you can聽
have an LLC without an S Corp, but to obtain S聽聽
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Corp status. You first gotta have your LLC.
Quick interjection as we're editing here,聽聽
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I misspoke. You can have an S Corp without聽
an LLC. What I should have said is you have聽聽
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to have some sort of business entity. So you聽
might be a sole proprietor instead of an LLC.聽聽
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So just know that as I'm explaining all of this,聽
that's what I actually mean. Your S Corp will聽聽
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have to have some sort of business entity,聽
whether that is an LLC or something else.聽
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And then you get to decide, does my tax聽
classification make more sense as a sole聽聽
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proprietor, a partnership, an S Corp, or a C Corp?聽
We're specifically gonna talk about S Corp here.聽
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An S Corp also known as an S corporation, also聽
known as an S subchapter is a tax classification聽聽
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that you can put your LLC into. There are聽
some limitations as to who can have an S Corp,聽聽
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but most small business owners easily meet those聽
requirements. And the tax benefits usually can be聽聽
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really beneficial. So it is a popular choice.聽
Okay? So this is where things start to get a聽聽
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little bit more technical and I'm gonna stick聽
to my notes so that I describe it really well.聽
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The first thing to understand about the difference聽
between an LLC and an S Corp is how you actually聽聽
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take your profits from the business. An LLC聽
owner takes distributions only. Distributions聽聽
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are basically just your profits you're getting聽
paid from the LLC or from the business.聽聽
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S Corp owners are called shareholders now.聽
So now you're a shareholder instead of just聽聽
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a business owner, you take the same amount聽
of money, or you can take the same amount of聽聽
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money. That's totally up to you, but you're聽
gonna break it into two categories. Okay,聽聽
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you're gonna take some of that money as聽
an employee now of the business. So you're聽聽
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gonna take it as a salary, and you're gonna take聽
some of it as distributions, just like you did聽聽
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as a LLC owner, because you're doing this,聽
this changes the way that you pay tax, which聽聽
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can decrease your taxes in some cases, but not聽
all of them. We'll get to that in just a second.聽
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So an LLC is gonna pay income聽
tax and self-employment tax聽聽
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on the entire profit that they take while an S聽
Corp is gonna pay income tax on the entire amount聽聽
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but self-employment tax only on your salary.
How S Corp Decreases Taxes聽
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What this is doing is limiting the double聽
taxation that small business owners can incur.聽聽
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The same dollar gets taxed twice once when聽
the company is holding it. And once when it聽聽
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makes it into your personal bank account.
So let me give you an example, and I found聽聽
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this example online, let's say you make a hundred聽
thousand dollars as profit, money that you get to聽聽
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keep from the business after your expenses.
A 100K as an LLC means that you're gonna聽聽
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pay self-employment tax, which is currently at聽
15.3% on the full 100K plus you're gonna pay a聽聽
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personal income tax of 24%, right? So you are聽
paying that tax twice on the same amount of money.聽
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With an S Corp you might take the same 100K聽
but now you're gonna take a salary of 60K聽聽
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and you're gonna take a distribution of 40K,聽
same hundred split into those two categories.聽聽
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You're gonna pay that personal income tax聽
now on that 100K, but you're gonna pay聽聽
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your self-employment tax, that 15.3% only on聽
the 60K plus you're gonna pay some payroll taxes聽聽
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that you weren't paying before as an LLC.
Given these numbers, your tax liability as聽聽
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an LLC would be about $39,000 and as an S聽
Corp would be about $33,000. So even though聽聽
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you're paying more in, in terms of payroll聽
taxes, overall, your tax burden is decreased.聽
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To give you another example, the first聽
year I moved my LLC to an S Corp.聽聽
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My tax bill went from 17,000 to 7,000, simply聽
because I wasn't being double taxed anymore.聽
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I was way overdue on setting up an S Corp, by the聽
way, you might not save that same amount of money聽聽
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the first time you do it, it's gonna depend on聽
how much profit you're already making. So if聽聽
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you've delayed moving to an S Corp for too long,聽
you've been getting double taxed up to this point,聽聽
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and you're gonna save a lot of money. If not, what聽
you're gonna do is prevent the loss of a lot of聽聽
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money instead. The reason I waited so long though,聽
is because I was told like everybody else, an聽聽
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LLC saves you money on your taxes. No, an LLC by聽
itself does not an LLC with an S Corp set up and聽聽
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paid for will. So definitely make sure that you聽
understand which is which and which one's right聽聽
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for you, which by the way, let's talk about that.
Drawbacks of an S Corp聽
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Let's talk about the drawbacks of an S Corp so聽
that you can understand what's right for you.聽
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So number one drawback of an S Corp is聽
that not all states will recognize an S聽聽
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Corp status. So you really need to make sure聽
you're doing your homework here to make sure聽聽
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that this will even make sense for you.
The second drawback of an S Corp is that聽聽
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you now have to pay yourself on payroll, which聽
just complicates the process of paying yourself聽聽
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especially if you're a solopreneur, who's聽
gotten away with not having to do payroll.聽聽
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You're just doing distributions. You're taking聽
cash. You're taking profit from the business.聽聽
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You don't have to worry about anything else, but聽
with payroll, it gets complicated. You gotta pay聽聽
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all kinds of payroll taxes. You got all kinds聽
of quarterly things happening. You gotta make聽聽
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sure you send yourself a W2 or W9, which one is聽
I can never remember. You can tell, I do not do聽聽
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my own payroll. This is an added expense. And it's聽
also an added headache for some business owners.聽聽
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So you need to take that into account as well.
The third drawback of an S Corp is that you cannot聽聽
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set up an S Corp unless you are making enough to聽
pay yourself what is called a reasonable salary.聽聽
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Talk about a vague tax code. A reasonable salary聽
basically just means the IRS is not gonna dictate聽聽
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how much you pay yourself, but you do have to聽
be able to justify it. So if you wanna try to聽聽
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decrease your tax bill by paying yourself $10 a聽
year, you're not gonna be able to justify that.聽聽
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But if you were to get audited and say to the聽
IRS, you know, I'm paying myself this much because聽聽
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this is how much it would cost if I were to聽
hire somebody or, you know, this is whatever聽聽
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the justification is, you gotta be able to justify聽
it. And so you gotta really think for yourself,聽聽
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what is a reasonable salary based on my聽
profit, based on what I do in the business,聽聽
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based on how many hours I work and all of those聽
things, if you can justify it, then it would be聽聽
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considered a reasonable salary. But if you cannot聽
pay yourself enough yet you're not making enough聽聽
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profit to take a reasonable salary. Then it聽
does not make sense to have an S Corp because聽聽
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nine times out of 10, you're gonna pay more to聽
have the S Corp than you're gonna save in taxes.聽
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I do have a rough ballpark number of how聽
much profit you might wanna be making聽聽
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that is based on what a CPA told me and聽
my business. So do keep that in mind,聽聽
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but I will get into that in just a second.
The fourth drawback of an S Corp, you are gonna聽聽
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have much more complicated taxes, meaning you're聽
probably not gonna DIY it unless you're really聽聽
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good at taxes. And this usually means that you're聽
gonna pay more to be able to get your taxes done.聽聽
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We pay roughly about $1500 to聽
$1800 right now with one S Corp.聽聽
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My husband just set up his second S Corp. So聽
we're expecting that bill to go up some more. This聽聽
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only makes sense for us because although we're聽
paying more in the short term with payroll fees,聽聽
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with payroll taxes, with CPA, with all of those聽
things, we're gonna save on the back end because聽聽
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our overall tax bill is gonna be lower.
When to move to an S Corp?聽
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So knowing all of this, when should you聽
consider moving to an S Corp? Again,聽聽
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number one, make sure you talk to your CPA聽
or a tax lawyer about your specific unique聽聽
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business, but here are some things to consider.
First of all, if your company has profit left over聽聽
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after you pay yourself a reasonable salary.聽
So figure out what that reasonable salary is,聽聽
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right? Let's say you're gonna pay yourself $50,000聽
a year. If you've got money left over after that聽聽
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50,000, it might be time to switch over. This聽
usually happens between $50,000 to $70,000 again,聽聽
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depending. So this is again where you聽
gotta talk to that CPA to really make sure,聽聽
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but at least you have a rough ballpark.
Another consideration, if you are reinvesting聽聽
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your profits back into growth right now, it might聽
actually benefit you to stay a sole proprietor聽聽
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for a little bit longer, because you're gonna be聽
writing those investments off, which means you're聽聽
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not gonna have a lot of distributions, which聽
means you're paying fees for an S Corp that you're聽聽
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not fully utilizing. You're not getting the tax聽
benefit because you're not taking those profits,聽聽
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you're reinvesting it back into the business.
So hopefully all of this clears up some of it聽聽
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for you, so that now you feel a little bit more聽
educated and can make some phone calls to that CPA聽聽
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or that tax lawyer to make sure that you get聽
everything set up the way it needs to be set聽聽
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up. That is not something I can help you to do聽
as a business coach. However, I can help you to聽聽
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create a business plan that maximizes your profit,聽
but decreases your time so that you're not burning聽聽
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out. And if that sounds like something you might聽
be interested in, be sure to learn more about my聽聽
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Healthy Hustle Approach, my free class, How to聽
Use a Holistic Approach to Create a Profitable聽聽
[888]
Business Without Burning Yourself Out will show聽
you the top three mistakes small business owners聽聽
[893]
are making and introduce you to the approach聽
and strategies I teach within the Breakthrough聽聽
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Boss Inner Circle to help you build reliable聽
profits working less than 40 hours a week.聽
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You can find a link to that free class in the聽
description below. Be sure to give this video聽聽
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a thumbs up if you found it helpful, that聽
helps me out a lot as well so thank you.聽聽
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Leave a fist bump in the comments if you made it聽
to the end. And let me know your thoughts on what聽聽
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you think is better for you, an LLC, or an S Corp,聽
and then be sure to check out these next videos聽聽
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on how to grow your business. Thanks for聽
watching. I'll see you in the next one.
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