Episode 26: What Works Wednesday: LLC Taxed As An S Corp

In today's episode of "What Works Wednesday," we tackle the often-misunderstood realm of tax options for LLCs. Contrary to common belief, an LLC is not inherently tied to a specific tax status; rather, it offers flexibility in how it can be taxed. In this installment, we shed light on a savvy strategy—opting for S-Corporation taxation within your LLC—to unlock potential tax savings. While default LLC taxation involves a pass-through structure, where profits and losses flow to individual tax returns, electing S-Corporation status allows for a more nuanced approach. By receiving a portion of income as a salary and the rest as distributions, business owners can sidestep certain self-employment taxes, resulting in substantial financial advantages. Tune in to "What Works Wednesday" to gain valuable insights, demystify the tax landscape for your LLC, and embark on a journey to maximize your yearly tax savings.

Links:
PeaceLink Financial Planning

TRANSCRIPT:

Leland Gross (00:01.758)

All right, welcome back to another episode of What Works Wednesday. Today, we're going to take on taxes as a conversation, self-employed taxes. Now, taxes is a huge sphere, so we could have a hundred episodes on just tax deductions, tax filing, paying quarterly versus annually. There's a lot there. But we started What Works Wednesday talking about the importance of having an LLC and the fact that an LLC is not a tax vehicle.

it's a limited liability vehicle. But you hear people say it's a tax benefit, it's a tax status. And so I wanna address why that is. And one of the main reasons why people think of LLCs and they think of taxes is because an LLC is a chameleon when it becomes a taxes, meaning it can take many different shapes. It's very flexible because it's an entity that protects you from liability. And then it says, well,

How do you file? Do you file as a single member LLC, which gets taxed the same as a sole proprietorship? Are you a partnership that has an LLC? So we need to tax as a partner or a partnership. Are you gonna file as an S-corp? Are you an S-corp with an LLC? And so I wanna talk through a couple of these different options because it is really powerful, but there's a lot of misinformation out there.

a lot of bad education out there, especially on social media, on YouTube, things like that. So I'm going to take it from a high level for the sake of time. I will just claim that you should definitely talk to a tax advisor, a CPA, if you're going to go through the process of deciding, hey, what's the best way for me to get the most benefit from my business from a tax perspective? What's the right entity structure and tax structure for me? But

Let's dive in. So again, you have an LLC that in and of itself is not a tax vehicle, but it allows you to decide how you're going to get taxed. Now, if you have more than one owner, you're automatically going to default into a partnership where everything just passes 50-50 to each of you, unless you say otherwise. And if you don't do anything else, you're going to automatically default into a single member, which is the same as a sole proprietorship. Now, how those work

Leland Gross (02:25.93)

I'm going to start with single member because it's easier and partnership isn't much different, is let's say you have your business and it has $150,000 of revenue, $50,000 of expenses, and you get net income of $100,000 from the business, from expenses, not taxes. So gross income to you is $100,000. Well, if you're a sole proprietorship or a single member LLC, you will pay

federal income tax, state income tax, and something called self-employment tax. Now for W-2 employees, they pay FICA, which is their Social Security, their Medicare, Medicaid. That's seven and a half percent of everyone's paychecks. And then the employer pays the other seven and a half. Well, self-employment tax, because you are the employee and the employer,

you have to pay the full 15. So it's a large tax for Social Security, essentially for you, on the full amount of the business's net income. Now, same thing with a partnership, but it just gets divided by the partners. And so if you're 50-50 partners, you divide that 150-50. Now, a lot of people you'll hear will say, well, I'm an LLC tax as an S-Corp. The benefit of the

The reason why that's important is because it allows you as the business owner to decipher and to divide when you are acting as the employee and when you're acting as the employer. Because for Leland Gross Financial Planner, there are days where I am doing financial planning. I am working with clients, I'm getting new clients, I'm doing investment analysis and things like that, and I'm acting as an employee of Peacelink Financial Planner. And then there's days where I'm...

doing business projections and working on the business and kind of thinking strategically as a business owner. And those days I'm a business owner. So what I can do as an S Corp is I can say Leland Gross employee got paid a reasonable salary of $60,000 this year, W2. So I pay myself a salary. And of that salary, it's federal, state tax.

Leland Gross (04:48.726)

FICA, seven and a half, but since I'm the employer, I pay the other seven and a half. So essentially, I pay self-employment on the 60, not on the 100. Now, the 40 remaining in the business is profit to the business. But because I'm the owner of the business, I can also take that as a distribution, which then means I've still paid myself 100 like I would have if I was single member or sole

Leland Gross (05:20.69)

But on the profit distribution, I only pay federal and state. I do not pay self-employment tax. So it saves me that 15% tax on the $40,000 of profit in the business. So it's a really powerful tool as you go up the income ladder. As your revenue grows, as your net business income grows, you can pay yourself more and tax yourself less.

Couple caveats with the S-Corp. You cannot just pay yourself a dollar salary. The IRS is very smart. They know what you're trying to do. So if you're gonna pay yourself a salary, it has to be reasonable to your profession. So you can't just say, well, you know, every other financial advisor out there makes $60,000. I'm gonna make, I'm gonna pay myself 20. It's not reasonable. So you have to pay yourself a reasonable salary. Now you don't have to pay yourself the highest reasonable salary either.

It just has to be a realistic, this is what it makes sense to get paid in this position if it was W-2. You also have to set up payroll. There's some administrative costs if you choose that S-corp election on your business. You have to pay for payroll. It's gonna add a different, you're gonna have to pay more to have your taxes filed because there's extra filings required. So you wanna make sure that the numbers work out.

where the tax savings by doing that, that there's enough profit that's getting paid out to you that's saving you in taxes, makes more than the added administrative costs of having payroll and different tax filing and things like that. So you can do the S-Corp filing if you're a partnership, you reach W-2 and then you distribute your profit. One of you can be W-2, the other one can be just a part owner and gets profit.

Or you can go the single member slash partnership realm without the S-Corp where you're gonna pay federal, state, and self-employment tax. One is not necessarily automatically better than the other. Again, it depends on your business, your situation, what income levels you're at. You know, if it's a relatively new startup and it's not churning out a lot of income yet, you're in the building phase.

Leland Gross (07:43.266)

doing it without the S-Corp is gonna make a lot more sense, right, because you don't have to pay all those extra administrative costs and the self-employment tax isn't huge. Also with self-employment tax, I don't wanna get too far in the weeds, but with an S-Corp, you lose self-employment tax, so you don't get to write off half of self-employment tax. Whereas self-employment tax, half of it is a deduction on...

the schedule C side, which schedule C is another is the actual tax schedule for single member LLCs. So that was nitty gritty right there. But all that to say, that's why it's important to work with a professional, whether it's a financial planner, a CPA, someone who has an actual expertise in small business taxes, to say, all right, if you go schedule C with self-employment tax, this is what it's going to cost you. If you go

LLC taxed as an S-Corp, this is what it's going to cost you. And to really flush out those numbers. But that is why people say an LLC is a benefit from a tax perspective is because if I'm just a legal and gross sole proprietor without the LLC, I'm just going to get taxed as a sole proprietor with self-employment tax. Unless I filed my entity as an S-Corp. Otherwise I can have the LLC where I can.

choose what to do. I can choose to file as an S-Corp. And it gives a lot more flexibility from that perspective. All right. I hope that helps. Always make sure to run these numbers by a professional. I am happy to do it, but I also you're watching me on the screen, so I can't do that right there. And go forth, build the life you want out of your business and prosper.