A stroke of genius- saving money if you are self employed.

If you start your own business, it makes sense to do some planning in advance. If you are successful, there is a way to avoid heavy taxes, including self employment tax. But you must act within the calendar year to be successful.

Left to your own devices, if you do nothing, at the end of the year you will be required to complete a schedule C to attach to your tax return, which will subject you to both income and self employment taxes. Self employment taxes alone will cost you 15.3% for every net dollar you earn.

In addition, you are subject to liabilities with your business. You could be open to personal liability for all of your activity.

Most attorneys will recommend forming an LLC. This will limit your liability, but it will do nothing to prevent you from incurring the self employment and income taxes that result from a successful business.

As a CPA, I recommend forming an S corporation. This creates a structure of both having legal protection &  tax protection. The forming of an S corporation identifies you as having two different roles: both as a shareholder of the company and as an employee. To the extent you are employed, you will have earnings subject to income and social security taxation. But to the extent you are a shareholder, you receive dividends, or profits, subject to income tax but NOT social security taxation.

There are ramifications to this structure:

  • You must draw reasonable compensation for the entity.
  • You must make sure enough withholding is taken off this compensation to cover your anticipated net earnings for the business.
  • You will incur some small residual taxes, such as unemployment tax for your wages, and an Illinois S corporation replacement tax for the net earnings on this entity.
  • And, you will have to file a separate tax return for the S corporation, which adds additional administrative costs, as well as needing to have a complete set of books and records for the entity.

If you are an organized individual who is on top of daily receipts and disbursements; have a good bookkeeping system and good support system in place, this should not pose any problems. Clients though who lend themselves to disorganization tend to have difficulty being in compliance and resenting the additional paperwork involved.

One thing that has not been discussed-  What if your attorney has already converted you to an LLC, what then?

Here is “what then”:

  • You have some relief… You can elect to retain the legal status of an LLC, but elect to be TAXED as an S corporation.
  • You simply file the elections and requests, and convert your activities to resemble that of an S corporation.
  • The IRS almost always grants permission for the conversion. So you can retain the LLC and save on taxes- keeping both your attorney and your accountant happy.

For further information, please feel free to CONTACT US – we are happy to discuss your individual situation; It’s what we do!