Saving 15.3% in Self-Employment taxes with an S-Corp?

Question

RECPATAXMAN, 
If you could go into a little more detail on this S-corp SE savings. 
I'm not clear on how the  end of year dist. will be excluded of S.E. tax.

I'm currently interviewing Atty's to setup my first LLC and have mentionrd to 2 of them my intentions of forming maybe an S-corp and so far both have talked me out of it. I'm still not positive they are the end all answer to my question as this board has been right more than wrong for me. Next week I'll be meeting with a Real Estate CPA to discuss my future business setup and will again address this issue. I only want to do this once. So I'd like to get it right the first time.

F.Y.I.  I reside in Michigan, My intentions are to buy and flip a couple of properties a year.

Thanks again for all the great advice in the past.
Dean

Dave Toelkes · Answer

If you read on 27 different sites that an S-Corp is better for flipping, did the sites tell you which entities are being compared to the S-Corp.

If the choices are between S-Corp, C-Corp and sole proprietorship, then I agree that the S-Corp may be better if you are only considering total tax liability.  There are personal circumstances which may make the C-corp the better entity.

As long as we are speaking in generalities, I would argue that the LLC treated as an S-corp is a better entity than an S-corp.

There is no one size fits all answer here.  Which entify is best for you depends upon your personal circumstances.

Marko Petrekovic · Answer

Dave,

I agree with you it's just I don't know who to trust so while I am looking for CPA I am reading forums, articles, books and after all this reading I feel like I know what my next step would be. When I come to next problem I'll look for CPA and read again and I'll see what I will find first: him or the answer. I know You can not trust one forum or one  persons opinion, but when I red on 27 different websites that s-corp is better for flippers, then I don't wont to pay somebody $300 to confirm me that fact. Now I am researching which is state better to open s-corp: Nevada or Wyoming (since I am not buying in my backyard)

J Scott · Answer

Why does it matter if your LEGAL entity is an S-Corp or an LLC???

You can have your LLC taxed as any entity you wish (including as an S-Corp), and an LLC is much easier to manage than a corporation and generally much cheaper to set-up.

As such, I'd think an LLC taxed as an S-Corp is a much better set-up (this is what my CPA recommends and what I've been doing myself).

Steven Dicker · Answer

Joe:

I have been trying to reconcile the tax savings in your example and cannot.  Under an LLC, SE taxes would be $18,360 (120,000*.153).  Taxable income would be $120,000 less $9,180 (1/2 SE tax) or $110, 820.  Total tax of $40,161 leaves $21,801 income tax or 19.7% of $110,820.00

Under S-Corp scenario, K-1 would be $70,000 - $7,650 (Fica) or $62,350.  W-2 would be $50,000 for a total of $112,350 in taxable income.  Income tax of $25,624 would be 22.8%.  Where am I going wrong?

Also is the basis for taxable distributions retained earnings?

Mark N.A · Answer

Joe Wilson:

Thank you for your informative post on the SE tax consequences of flips.

All the more reason for me to buy and hold or do the 'slow flip'.

Scott Williams · Answer

For me finding a good cpa was like finding a winning lottery ticket. Well almost anyway :lol:

I have a hard enough time just fulfilling all my responsibilities on a weekly basis, having someone who will help me with keeping more of my money is a huge asset and for me at least money well spent.

Things change with taxes and my personal situation each year. Having an expert on my side is a no brainer for me.

Actually not to sound like a moron but I work alot and have a hard time just doing what he tells me sometimes, let alone figuring out what the best option is in the first place.

The trick is finding someone who cares about your business and will really help you, rather than some large firm with bigger fish to fry that just goes through the motions and sends you a bill.

Marko Petrekovic · Answer

Joe,

I have similar situation like Dean D, just started with flipping and am about to set up an entity. My question is: since you explained everything, why do we need additional consultation with CPA or attorneys, which of course cost money, when you told us exactly what to do, so we can go online now and set up S-corporation??? How hard can it be?

Jesse Norell · Answer

I'm curious how that went, if you'd care to reply.

Thanks,
Jesse

Joe Wilson · Answer

With a business of flipping houses, you would be subject to SE tax if you were an LLC (page 1 income).  If you chose to form an S-corp, then you would only be subject to the FICA tax up to the point of the wages the S-corp paid.

If this is a part-time type of operation, then you may have opportunity to have a lower wage base or set commissions paid to you for each house that was flipped.

If this is a full-time, sole income generator, then you will want to set a reasonable, but as low as possible, salary and keep the profits in the S-corp.  The profits in the S-corp can be distributed as a non-dividend distribution which is not taxable and will not be subject to FICA tax.

If you have a full-time job and earn more than $94K+, then your income from this operation would not be subject to FICA because you would be over the limit and you can form an LLC.

If your spouse does not work and you do and earn more than $94K+, then you would not want your wife on the LLC documents because her half of earnings would be subject to the FICA (SE tax), but you would not because you had already hit the limit.

Confused???  It does get confusing, but you can save money and taxes if you are an S-corp, pay yourself a modest salary and the rest of the profits, which will be reported by you and pay income tax on, is not subject to FICA or SE tax.

Since rehabbing will be your business, I don't see this being investment property nor capital gain (short or long term).  All the houses will be inventory and property held for sale to customers.  All ordinary income reported on page one of the 1065 and subject to SE tax.

Example:  If you flip 4 houses in one year and clear $30K on each one, then you have $120K income for the year.

LLC:  $120K subject to SE tax and income tax on your 1040 would be $40,161, so that is $79,839 cash in your pocket for the year.

S-corp:  $120K income and pay $50K in wages as salary.  Your FICA taxes would be $7650 (1/2 paid by the S-corp & 1/2 paid by you from wages).  Your income tax on your 1040 would be $25,624 for a total of $33,274.  Net cash would be $86,726.  You would have enough basis to cover your distributions so none of the cash that you pull out would be subject to tax.

You can set your salary arbitrarily low, say $500 a month and then in December pay yourself a bonus depending on how well you performed during the year (bump your wages say up to 25-33% of your net income for the year) and pay in additional Fed income tax withholding to cover all the estimated tax payments for the income you generated in the S-corp and you have full use of the funds for the year and saved some taxes.

Interview CPAs and maybe find some CPAs that have gone out on their own from a large firm or good sized regional firm.  Do you have any contacts at banks that may recommend a good CPA.  You can pay $300-500 for tax return guidance and prep, but you are going to get someone who will say just set up an LLC and be done with it (additional $7K in tax) or pay $1,500 for your business and personal return and you will get some advice like I have given and they will help implement your plan.

You do get what you pay for.

Joe