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When Does an S Corporation Make Financial Sense? | Sole Proprietorship vs. S Corporation - YouTube
Channel: Navi Maraj, CPA
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When should your business be taxed as an聽
s-corporation that's going to be the topic聽聽
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of this video and specifically when does it make聽
financial sense for your business to be taxed as聽聽
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an s-corporation so um i'm going to be talking聽
about how the s corporation saves you money聽聽
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the cost associated with having an s corporation聽
and sort of what is the break-even point how much聽聽
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profit do you need for it to make sense to be聽
taxed as an s-corporation this is your first聽聽
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time watching my name is Navi Maraj i'm a cpa聽
that specifically works with realtors around聽聽
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the country save thousands of dollars in taxes聽
but if you're not a real estate professional聽聽
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please do continue to watch because this strategy聽
really applies to all small businesses um so let聽聽
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me just lay the foundation here um i on my youtube聽
channel you'll find a video that i shot recently聽聽
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where i said hey there are four reasons where i聽
believe you should not have your business taxed聽聽
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as an s corporation um and that's right you heard聽
me say four reasons why not to okay um everyone is聽聽
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talking about why you should be an escort but i'm聽
telling you there are reasons why you shouldn't be聽聽
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some of those reasons are and you know the topic聽
of this video is um you know you're not making聽聽
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enough profit for it to make financial sense and聽
we're going to take a deep dive into that in this聽聽
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video but the other reasons were if you might have聽
w2 income so you are employed somewhere you make聽聽
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a high salary but you also have a business on the聽
side it may not make sense for your business to be聽聽
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taxed as an s corporation another reason might be聽
your state does not recognize the s corporation or聽聽
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taxes it very heavily and so you don't see any聽
real tax savings there um and the fourth reason聽聽
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was you pretty much do passive activities in聽
the eyes of the irs an example of that would be聽聽
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investing in buy and hold rental real estate聽
where you are the landlord and you have a tenant聽聽
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and you just make passive income which is that聽
rental income in that situation you would not聽聽
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want to be taxed as an s corporation so this聽
again this video is going to be taking a deeper聽聽
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dive into sort of reason number one which was聽
um you know you may not be profitable enough聽聽
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and it may not make sense so let me sort of聽
transition to the whiteboard here and we'll聽聽
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dive into this okay so i'm saying here that if聽
your business is taxed as a sole proprietorship聽聽
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or maybe it's a single member llc which is聽
taxed as a sole proprietorship i know that聽聽
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already might be a little bit confusing i've聽
got videos on my youtube channel that talk about聽聽
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you know when to form an llc corporation all that聽
different stuff so watch that video that'll make聽聽
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more sense so i'm saying here your tax is聽
a sole proprietorship so you had a revenue聽聽
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of sixty thousand dollars yet expenses of twenty聽
thousand dollars which left you with a profit of聽聽
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forty thousand dollars right some of you might聽
be saying wow 20 000 expenses that's kind of high聽聽
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considering you only made 60 000 in sales聽
well you know when you work with an accountant聽聽
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who knows about different tax strategies聽
they're going to show you strategies that聽聽
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sort of increase your expenses and so that's why聽
i kind of put twenty thousand dollars in expenses聽聽
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there so your profit is forty thousand dollars聽
so what taxes do you have to pay as a small聽聽
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business owner you know making forty thousand聽
dollars a profit well you pay two types of taxes聽聽
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those taxes are self-employment taxes so you'll聽
pay fifteen point three percent of the profit in聽聽
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self-employment taxes so that equates to about six聽
thousand dollars and you'll have federal income聽聽
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tax that you'll have to pay on the forty thousand聽
dollars so i don't know where you're gonna fall聽聽
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within the tax brackets zero percent is probably聽
not realistic but you're probably falling between聽聽
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ten and as upwards of forty 40 um depending on聽
what you know if you have state income tax or not聽聽
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so again you pay two types of tax on your profit聽
self-employment tax federal and state income tax聽聽
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but what happens when you're an s corporation聽
right what is this strategy all about well聽聽
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this strategy is all about self-employment tax聽
so what i'm trying to drive home here is that聽聽
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it has nothing to do with income tax okay this聽
all has to do with self-employment tax you're聽聽
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going to pay the income tax at about the same rate聽
when you're an s-corporation but what changes is聽聽
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the self-employment tax so specifically you know聽
you still have forty thousand dollars in profit聽聽
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when you're in s-corp right you didn't sell聽
any more product or offer any more services聽聽
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when you're in s corp but what happens is this聽
forty thousand dollars in profit is split into two聽聽
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buckets right so i call i put w2 here what i mean聽
by that is the irs wants you to take a reasonable聽聽
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salary when you're an s-corporation so here聽
i'm saying on forty thousand dollars of profit聽聽
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that reasonable salary might be about half聽
it might be like fifty percent of this so聽聽
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you'll take a salary of twenty thousand dollars聽
and that salary will pay self-employment tax um聽聽
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so 20 000 times the 15.3 percent you're gonna聽
get self-employment tax of about three thousand聽聽
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dollars right now what happens to the other half聽
you know the second bucket well that second bucket聽聽
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you're going to take as a distribution from your聽
s corporation and so how much self-employment tax聽聽
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do you pay on the distribution and the answer聽
is zero so you don't pay any self-employment聽聽
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tax on distribution on the distribution so in this聽
example as an s corporation you pay three thousand聽聽
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dollars in self-employment taxes whereas here you聽
paid um six thousand dollars in self-employment聽聽
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taxes so you have a savings of three thousand聽
dollars right the six thousand here versus the聽聽
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three thousand there gives you a three thousand聽
dollar uh tax savings again federal income tax聽聽
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you're gonna pay that here and you're gonna pay聽
that as an s corp so that really doesn't matter聽聽
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so what are the costs associated with having an聽
s corporation so you're going to have a few you聽聽
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might have a couple more than these but these are聽
the big ones so you're going to have to either聽聽
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form an llc or create a corporation and then聽
elect to have it taxed as an s corporation and so聽聽
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when you form that llc or corporation you are聽
going to have to file an annual report with聽聽
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your state each year and the fees on that聽
depend or change i should say from state to聽聽
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state right so this could be as cheap as 100 it聽
could be as much as 300 so i'm just saying 150聽聽
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another fee that you'll have is tax prep fees so聽
you know if you're dealing with a competent cpa聽聽
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or accounting professional who is taking the time聽
to teach you strategies implement those strategies聽聽
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they're probably going to charge you anywhere from聽
800 to 1200 okay so i'm saying you know your tax聽聽
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prep costs might be about a thousand dollars聽
if you're working with you know a not so good聽聽
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accountant who's just gonna take the numbers that聽
you give them and throw it in their tax software聽聽
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then maybe you can get away with paying less聽
but again you get what you pay for you might聽聽
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end up paying more in taxes if that's the type聽
of professional that you decide to work with聽聽
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other costs you have are payroll i believe i聽
said earlier that with an s corporation you聽聽
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have to take a quote-unquote reasonable salary聽
per the irs trust me you probably don't want聽聽
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to be dealing with the paperwork associated with聽
having payroll because you have to make either um聽聽
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or not either but both quarterly and annual tax聽
reporting requirements and so you really don't聽聽
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want to deal with that you want to be focused on聽
running your business and growing revenue and so聽聽
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you'll hire a payroll processing company to do聽
that so that might cost about 50 bucks a month or聽聽
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600 for the year so when you add up all these聽
costs you get about 1 750 right so from here i'm聽聽
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saying this is kind of like the break-even point聽
where i think it makes sense to maybe have your聽聽
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llc taxed as an s-corporation because you know you聽
would have been paying 6 000 in self-employment聽聽
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self-employment taxes here now you only have to聽
pay three so you save three thousand dollars in聽聽
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taxes but then you have these costs right so when聽
you take the three thousand dollars of tax savings聽聽
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and you deduct the seventeen hundred fifty dollars聽
in additional costs you're really pocketing about聽聽
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1250 dollars in your pocket right so you don't聽
want to deploy this strategy to break even聽聽
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you want to deploy this strategy when you can at聽
least make you know 1200 and put that back in your聽聽
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profit but what about when you start making more聽
money than this right what about if your profit聽聽
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is more like sixty thousand well and then in that聽
example you might tweak some of these numbers you聽聽
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might tweak how much you get paid in the form聽
of a salary versus a distribution and so you聽聽
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might save more like fifty five hundred dollars聽
in self-employment taxes or if your profit is聽聽
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seventy five thousand dollars then you might save聽
more like sixty five hundred and if your profits聽聽
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you know a hundred thousand dollars or more聽
then you can easily save ten thousand dollars聽聽
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in taxes sort of by deploying uh this strategy聽
right um so i hope that you found this video to聽聽
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be informative and you receive some value out of聽
it maybe i cleared some things up for you that聽聽
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are not so clear when you watch other videos聽
or you're trying to research this on your own聽聽
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as i mentioned earlier i'll be producing other聽
videos on those other three reasons where i聽聽
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said it may not be a good idea to be taxed as聽
an s corporation so you can learn the reason聽聽
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why i'm saying these things and apply it to your聽
small business so make sure you subscribe so you聽聽
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can catch that content as i release those videos聽
if you'd like to contact me and you're watching聽聽
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this on face sorry on youtube rather you'll聽
see the information below in the description聽聽
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or if you're on other you know social media聽
platforms and you're watching this video聽聽
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just visit my website which is navimarajcpa.com聽
or you know click on my profile within that聽聽
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social media site and i'm sure there's a聽
link in there to take you to my website聽聽
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or maybe my scheduling page to um spend some聽
time with me so i appreciate all the comments聽聽
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all the feedback i've been getting like i said聽
do subscribe and i will see you in the next video
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