When it comes to structuring your business, a lot of people think that S Corporations are the way to go. And in most cases that’s correct. If you’ve already read my book, you’d know I’m a huge advocate for S Corporations. It‘s an excellent way to structure your main operating business and take advantage of legal tax strategies.
Don’t get me wrong, my opinion hasn’t changed. S Corporations are still generally the way to go for your main operating business. But when you start putting multiple businesses into S Corporations. Because you heard that S Corporations are the best entity when you have multiple entities… it’s a problem for your bottom line that you aren’t even aware of.
It’s not unusual for business owners to create a multiple business entity structures to hold multiple business affairs. But in order to avoid paying any additional taxes when forming these entities. All tax consequences should be carefully considered with a tax planner. Always consult a tax planner when choosing what type of business entity will work best for you.
Before we jump into this tax strategy, I want to talk about this …
The Big Guy vs the Little Guy.
Whether you’re a little guy, who makes a couple hundred thousand every year. Or a big guy whose taxable income is 10 million. They both make the same mistakes with how they structure their entities.
Just because you’re a small business owner doesn’t mean that the mistakes you’re making aren’t the same that the big guys are making.
We have plenty of clients who are in that area. We have clients that are planning to go public but are delayed because they have entities that are structured incorrectly. We’re working on tax planning and restructuring their entities. So they will be able to go public while taking full advantage of legal tax strategies that are available to them. They make the exact same mistake that you would be making when it comes to structuring your business. But it’s easily avoidable when you have a tax planner on your side.
What’s the benefit of having an S Corp?
S Corporation is a business entity that has elected to pass its corporate income, losses, credits, and deductions to its shareholders. S Corps don’t pay income tax. Instead, the company’s individual shareholders split up the income amongst each other and report it on their own personal tax returns.
In plain English?
It’s a way of forming a business so that it avoids double taxation as compared to C corporations.
What’s the biggest problem with having multiple businesses within multiple S corporations?
Having multiple S corporations comes with paying MULTIPLE social security taxes.
And who wants to do that!
The IRS assigns every business structure a default tax treatment that determines how your business is taxed. Think of it as a set menu at a restaurant with no substitutions.
And in the United States we have all different kinds of taxes:
- Federal tax
- State & local income taxes
- Property Taxes
- Payroll taxes
- Social security
- Medicare Taxes
- Estate Taxes
- and there’s more …
S Corporations don’t pay income taxes and they avoid double taxation. Unlike their friends, C Corporations. But they’re taxed on profit that is passed over to each shareholder.
Now, imagine this ….
You’re not a business owner, and you work a job. Once you reach $147,000/year is when you will stop paying social security tax. Imagine you have multiple jobs and each is paying you $147,000/year, $147,000/year, and $147,000/year. You will pay some social security taxes on ALL these jobs. But you will get a refund at the end of the year for overpaying social security. (Which maxes out at $147,000/year).
However, the employers that you work for will not get a refund for the taxes they paid. Each of them will pay their portion of payroll taxes.
Meaning, when you own and run multiple businesses under S Corporations. You will not only have to pay for yourself a reasonable compensation for each business. But you also have to pay payroll tax for each of these.
To summarize, if you max out your salary over $147,000/year you will get a refund personally for the social security taxes that you overpaid. But the multiple businesses that you own will not get back the 6.2% in taxes for Social Security. Think about it… For every $100,000 that you pay yourself over the $147,000/year, that’s $6,200!
How to decide if an S Corp is the right decision for your business entity.
First things first, you need to define the purpose of your entity. Typically this is where business owners fail first. Incorrectly defining the purpose of that entity.
Obviously, the purpose is to produce this or sell this item. But this is not what I’m talking about. We know the business purpose, so to speak. But what is the purpose of this entity for YOU? What is the end goal of this entity?
Are you looking to grow and sell? There are much more favorable IRS codes and regulations for companies that are looking to exit the business in the future. But S corps are not one of them. These IRS codes and regulations encourage startups to grow and sell their business. And that sale could even be tax-free to you. But of course, there are certain criteria and qualifications that you need to meet. And we strongly advise getting a tax planner on your side to walk you through this process.
If you’re operating different businesses, your main operating business should be an S Corporation. This is where you take advantage of medical tax strategies, 401k, and any other tax strategies to maximize your tax savings. There are a lot of different strategies that a tax planner can implement for your business
We want to put as many deductions as possible in the S Corporation.
The purpose of the S Corporation is to avoid self-employment tax legally by paying yourself a reasonable compensation. Because this is a pass-through entity, it’s going to be your personal income tax earner which is taxed at the highest rate.. And in order to do this, you will want to consult with a tax planner to make sure you are maximizing all the tax deductions that are available to you.
Should you keep real estate rentals in your S Corporation?
The purpose of the S Corporation is to avoid self-employment tax legally by paying yourself a reasonable compensation.
Income from real estate rentals is not subject to social security and Medicare taxes. So, there is no reason why you should do it as an S Corporation.
The way to strategize around this would be to put those rentals into a separate LLC or a holding company. You will still be able to pass the income from those rentals to your personal finances. And have a management company take care of those rentals. But it really shouldn’t be in an S corporation.
The powers for LLCs and their tax advantages.
If you form an LLC and you’re the sole owner, you’re by default a disregarded entity. And as an LLC you can choose how you want to be taxed. You can choose to be taxed as an S Corporation, partnership, or a C Corporation.
Now you have your S Corp as your main operating business. And now you want to start a few other companies around your main operating business. When you start forming these companies, generally using LLCs will be the best… But always make sure to consult your tax planner.
- S corporations are generally the way to go for your main operating business.
- The big benefit of having an S corp as your main operating business is you pay less in taxes.
- The biggest problem with having multiple businesses within multiple S corporations is you pay MULTIPLE social security taxes.
- To decide if an S corp is the right decision for your business entity you need to define the end goal of your business by consulting a tax planner.
- Real estate rentals are not subject to social security and Medicare taxes. They are best kept as an LLC or holding company.
- LLCs will be the best option when forming other companies around your main operating S corporation. But always consult a tax planner.
How this fits into tax planning.
Think of it this way…
The past is in the past and there is nothing else you can do. You can’t go back and undo your entities or undo your salaries. What is done is done and you can’t go back and take advantage of strategies that you missed out on.
This is why it’s important for you to have a tax plan that a tax planner does for you. Sit down with your tax planner. Look at your life, look at your business and look at how you can strategies with your taxes.
This is extremely important in order to reduce the amount of money you are paying in taxes.
There are thousands of dollars every year that can be saved when you take advantage of legal, IRS-approved, and court-tested tax strategies.
If you are interested in tax planning and learning more about how the strategies above can fit into your business, tap here to book a free tax strategy session.