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S Corporations | S Corps Explained - YouTube
Channel: All Up In Yo' Business with Attorney Aiden Durham
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- Hi everyone.
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I'm attorney Aiden Durham with 180 Law Co.
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in Denver, Colorado.
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And you're watching,
All Up In Yo' Business.
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(upbeat music)
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In this episode of All Up In Yo' Business,
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we're gonna talk about S corporations.
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What is an S corporation?
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What does it mean?
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How do you become one?
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But before we get into it,
be sure to like, subscribe
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and share if you're so inclined.
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And if you subscribe, make sure you hit
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that little bell button
so you get notifications
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every time I post a new
video, so you don't miss out.
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Also, check the description below
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for some additional information
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and some freebie downloads and
some guides down there too.
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Also, if you've been watching
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the last couple of episodes that I posted,
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you know that I had some
foster kittens running around,
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who would make occasional
guest appearances in my video.
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We all loved them.
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Well, it's with a very heavy
heart that I must report,
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the foster kittens are no longer with me.
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Unfortunately, they came down
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with a touch of ringworm over the weekend
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and so I had to take
them back to the shelter
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so they can get treatment
for a couple of months.
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So I don't have any more fosters.
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But you know what, it's okay.
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You've still got me, and
we've still got Rocky here.
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We didn't forget about Rocky.
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So even though there are no more kittens,
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it's still gonna be a party.
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And I can safely report
I don't have ringworm.
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Rocky does not have ringworm.
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I spent the entire weekend disinfecting
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and cleaning my whole house.
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So we are ringworm free.
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Okay, moving on.
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S corporations.
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What is an S corp?
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An S corp is only a tax election
that a business can make.
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An S corporation is not a business entity.
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So you don't form an S Corp.
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You can form an LLC, or
you can form a corporation,
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and then either of those can elect
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to be taxed as an S corporation.
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The S corporation election is
really a way to take advantage
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of pass through entity taxation
and avoid double taxation
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like you would with a C Corp,
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while still limiting the
self employment taxes
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and limiting your tax
liability all together.
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So what difference does it make,
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what actually happens if you elect
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to be taxed as an S corporation?
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In a corporation, a
traditional corporation,
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the corporation has its own corporate tax.
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It pays corporate tax on its income,
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and then it pays dividends
to its shareholders
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and the shareholders have to pay income
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on what they've received as dividends.
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So, this is what we call double taxation
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because essentially, the
income is being taxed twice.
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It's taxed to the corporation
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and then it's taxed to the shareholders
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when they receive dividends.
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In an LLC there's no corporate tax.
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LLCs don't pay their own corporate tax.
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Instead, the members pay tax
on their portion of the income.
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They'll pay ordinary income tax
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plus self employment tax on
their income from the LLC.
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However, with the S corp election,
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the owners of the company whether
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it's an LLC or a corporation.
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The owners have to pay
themselves a reasonable salary.
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The term reasonable is very dependent
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on specific circumstances
and very fact dependent.
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So there's no like hard and fast rule
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about what a reasonable
salary is in an S corporation.
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There's a lot of different information
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and guidelines on how to figure it out,
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but for the most part,
people are just kind of
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going off of history with the IRS,
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and the information that is available
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to try to determine what
a reasonable salary is.
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But anyway, so that the
owners pay themselves
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this reasonable salary.
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And the salary is paid through
payroll because the members,
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if we're talking an LLC, once
the S corp election is made,
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the members now become
employees of the LLC,
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and are paid on payroll,
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just like any other employee would
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or just like you would
if you're an employee
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for some other company,
they pay you on payroll.
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The you know, FICA and
the taxes that we pay
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when we get a paycheck from our employer,
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those same things are taken out of
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the members reasonable
salary on their paycheck.
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So instead of that self employment tax
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being tacked on to the
entire income of the LLC,
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it's essentially just being tacked on
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to that reasonable salary of the member.
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So in order to demonstrate,
let's do a little math
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and kinda look at some of the numbers
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and see how it actually breaks down
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in an LLC versus an
LLC taxed as an S Corp.
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Let's pretend it's a single
member LLC, so only one owner,
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and the business generated
$100,000 of income.
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Now I'm completely
making these numbers up,
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these tax rates and stuff, don't depend.
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I'm just using them for
illustration purposes,
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these rates that I'm using aren't exact.
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And isn't exactly how tax rates work,
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but just for illustration
purposes, play along okay.
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So $100,000 income, let's say the owner
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is in a 25% tax bracket.
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So their ordinary income is taxed at 25%.
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And then on top of that,
is that self employment tax
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which is 15.3%.
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So 25% plus 15.3% is 40.3%.
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So essentially we're taking
40.3% of that $100,000,
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and that's the tax bill.
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So in $100,000, that single member LLC
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is gonna have tax bill of about $40,000.
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Versus in an S corporation,
we're still making $100,000,
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but instead, the member
takes a reasonable salary
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for the year that equals 50,000.
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We'll just say her salary is 50,000.
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That's what she and her CPA decided
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would be a reasonable salary.
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So now, it's only that reasonable salary
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that has those self employment
taxes applied to it.
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So she's getting a paycheck and out of
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that paycheck are the FICA taxes
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that would be taken out.
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Everything on top of that paycheck,
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on top of her reasonable salary,
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she can still take as
a member distribution,
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and that's only taxed at
her ordinary income tax rate
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without the self
employment tax added to it.
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So in total, she's paying about $32,000
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in taxes instead of $40,000.
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So in this instance, it's
not a huge difference,
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but again, I made up the numbers,
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and this isn't exactly,
exactly how they apply.
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But general idea, it's the same.
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So really, the ultimate goal is that
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we're portioning out the
income to the business,
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so that only some of it is
subject to self employment taxes,
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instead of all of it being
subject to self employment tax.
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And then in the context of a corporation,
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it avoids that double taxation
that you would normally have.
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So if you decide that the
S corporation election
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is the right thing for you,
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when and how do you do it?
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As an LLC, you can make
the S corp tax election
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on IRS Form 2553.
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Now there are some time restrictions
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on when you can do this.
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You can't just make the
election willy nilly,
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whenever you feel like it.
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You have to make the tax election
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within two and a half months from the day
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the business is formed in order
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for it to be effective for that tax year.
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So let's say you started
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your business in, on, June 1, 2019.
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If you want to be taxed
as an S corp for 2019,
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then you need to submit that
S corp election by August,
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middle of August, about August 15th.
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That two and a half month mark after
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is when your deadline is.
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But if you don't want to
do it for that given year,
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you can make the S corp election within
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the two and a half months of
each beginning of the year.
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So if you decide 2019, I don't
wanna make the election yet.
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I wanna wait until 2020, then I'll do it.
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So then 2020 comes around you have to file
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that S corp election by
middle of March, March 15th,
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in order to get it effective for 2020.
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And you don't have to continue filing,
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you just file it once, and
the S corp election is,
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it applies for every
year thereafter until,
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you know, the business
closes, or the tax changes
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or something like that.
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Now, while there are
certainly a lot of benefits
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and advantages to being
taxed as an S corp,
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there are certainly disadvantages too.
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It's not for everybody.
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First of all, the IRS places restrictions
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on who can make an election
to be taxed as an S Corp.
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The business, there can't be
more than 100 shareholders,
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so it's capped at 100 shareholders.
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All of the shareholders have
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to be US citizens or legal residents.
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And the owners, the
shareholders of the S corp
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can't be entities like LLCs
or corporations themselves.
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So you can't have an LLC
that is the member of an LLC,
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that's taxed as an S corp.
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And then S corps carry
along with them more
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administrative work, because you are
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now setting yourself up as an employee,
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you have to deal with payroll
and payroll tax filings.
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And then of course, determining
that reasonable salary,
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that's a huge issue that comes
with S corporation election.
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Making sure that reasonable
salary is an appropriate amount,
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because if you don't pay yourself enough
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on a reasonable salary, then
the IRS could come back later,
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and they'll apply those
self employment taxes
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to what you should have paid as a salary.
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And they'll tax on penalties
and interest and stuff too.
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So, I go so far as to
say if you're not willing
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to invest money into
good CPA or tax advisor
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who can really help you with this,
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then don't bother with the
S corporation election.
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If you're not willing
to, unless you yourself
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are tax expert and you can figure it out.
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If you're not willing to
have an expert help you
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with managing the S corp and
the taxes and all of that,
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then don't bother with it.
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Because ultimately, if you're
doing it wrong, it will,
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it will end up working way against you
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as opposed to being anything of a benefit.
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And I'll pull back the curtain a little
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and tell you guys about what I did.
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So when I started my
business, six years ago,
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I did not make an election
to be taxed as an S Corp.
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I didn't know how much money
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I was gonna be making in that first year.
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And I didn't want to have to deal
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with the hassle of being
taxed as an S corporation.
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I didn't wanna have to deal
with the extra administrative
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and payroll taxes and all
that stuff, so I didn't do it.
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But after the first year, I
brought on a CPA to help me
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with all my bookkeeping
because I was destroying it,
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and thankfully that CPA talked to me about
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the S corporation
election, and we determined
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that based off of my
business's income at that time,
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we would make the S corp election.
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And it started essentially in that
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I think second year
that I was in business.
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And ever since then, I'll
tell you exactly what I do.
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About every other week,
or maybe once a month,
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my accountant, emails me and says,
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"Here's how much we need to pay you."
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And then I say, "Okay,"
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and they brought in payroll,
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and it gets direct
deposited into my account.
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I literally have no idea
how much they're paying me.
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I mean, that's not true.
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I have an idea of where they're
getting these numbers from
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and what they're basing it off of,
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but I do zero math in my
head, they do it for me.
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I'm not even going to pretend
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to try to figure out
what my reasonable salary
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should be, because I have no idea.
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And so it's really that
kind of a situation
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where I recommend the
S corporation election
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is if you have somebody
who can guide you through
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the whole thing, so that
you're not in becoming
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a business owner plus makeshift CPA,
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trying to figure out how
to do your own taxes.
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And then I'll tell you guys
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what I typically recommend to my clients.
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If I'm talking to a client who
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is a brand new business owner,
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this is their first time
starting a business,
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their first foray into entrepreneurship.
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I tell them, let's not think
about S corp right away.
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Let's take a year.
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Let's go this first year,
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see what your income looks like.
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See how your business is going and see
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if you actually enjoy being
in business for yourself.
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Because if you're not making any money,
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then the S corp is not
gonna do you any good.
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And if you hate being in business,
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then again the S corp is
not gonna do you any good.
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So unless you're like super certain that
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you're gonna make a substantial amount
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of income in your first year of business.
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I'm talking like, I don't
know close to six figures
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in your first year of business.
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If you're not pretty darn
sure that's gonna happen,
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then typically, don't
worry about the S corp,
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just stay taxed as an LLC for you know
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that first year of business,
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see how things go, and then you can always
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make this S corp election
for the following year.
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Now, this, you know, this
doesn't apply to everybody.
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And that is why it is so super important
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when you're considering
starting a business
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and making an S corporation election
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or wondering if you should.
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It is super important
to talk to an attorney
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and a CPA or a tax expert,
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so they can in conjunction
with one another
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help to figure out if the S
corp is the right way to go.
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That's all for this episode, folks.
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Drop a comment below and
let me know what you think.
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You'll also want to check the description,
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I have a link to my blog where we go into
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some more depth about myths
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of S corporations and commonly
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misunderstood things about S corporations,
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so check there too.
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Thank you all so much for watching.
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I'm Aiden Durham, and
I'll see you next time.
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