Home > Taxes > Difference In Taxes-Sole Proprietorship vs Corp or LLC
Is there any tax benefit purely in the sense of taxes between being a sole proprietor and having an LLC or S Corp?
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In this audio snippet, you'll hear about:
- If its a question between being sole prop or being S Corp or LLC, there do appear to be certain tax advantages to being an S Corporation
- That answer is purely from the perspective of taxation
- Remember that the world doesn't revolve around taxes – there are a lot of other issues to be considered
- Sole prop with > $200K/year they pay not only income tax but also self employment tax of 15.3% on first 90K, 3% on anything above it.
- By incorporating as S Corp you can limit the amount of self employment taxes to the amount of salary that you take. The rest of the money you take would be considered a distribution from the corporation which would not have a tax effect.
Audio Transcript
Travis:
Now in general, is there any tax benefit, just purely in the sense
of taxes, between being a sole proprietor and having an entity like an
LLC or an S–Corp?
Yosef:
If one's choice is a question of being a sole proprietorship or being
an S–Corporation or an LLC, there do appear to be certain tax
advantages to being an S–Corporation. Now let me add, that I'm really
just answering this question purely from the perspective of taxation.
A
lot of clients, I've got to tell you, they're so excited about saving
money in taxes that they forget that the world doesn't just revolve
around taxes. There's really a lot of other factors that have to be
considered before one incorporates, and before one proceeds with any
business decision solely because of the tax implications.
I
have people who call me and say, "Hey I got this great new office space
that I want to rent. I can deduct it, right?" I'll say, "Sure, if it's
a legitimate business expense, a rental expense, why not?" But that
isn't the only reason to move offices, because you can deduct the
money. At the end of the day, it's also affecting your bottom line.
So
that being said, a sole proprietorship that's actually making money,
lets say, I used this example before, If they're earning, say, $200,000
a year, a sole proprietorship with that kind of net income is going to
be paying not only income tax but is also going to be paying
self–employment tax. The self–employment tax is 15.3 percent of the
first $90,000, and three percent on anything above that. That's a nice
chunk of money.
Travis:
Yeah.
Yosef:
Now, a lot of people don't care. They figure they want to fund their
Social Security retirement. We should all live long enough to actually
utilize the benefits of the system.
Travis:
Yeah, some of us bet it's still around.
Yosef:
I can only speculate, seriously, what may or may not happen there. I do
make it my business to ask people who I think may know the answer to
that question what they think, and nobody has any clear idea. The
Social Security administration themselves say that there is no way they
can continue funding the benefits that they are currently funding under
the current system.
Travis:
Right. But it is hard to tell how much of that is rhetoric, and how
much of that is going to be modified and reformed in future years.
Yosef:
I don't think anybody knows the answer and I think if somebody did they would win the presidency.
Travis:
[laughs] Well, I would vote for them.
Yosef:
[laughs] We all would believe it or not.
Getting
back to the question at hand, by incorporation of an S–Corporation you
can actually limit to the self–employment tax to the amount of salary
that you take. The rest of the money that you take out would be
considered a distribution from the corporation, which would not have a
tax effect, because, again, the incoming corporation is flowing through
to you individually anyway.
That being said, and again,
there are a lot of Treasury regulations that address this issue. If for
example, and I'm just trying to think of a very simple case. But then
no case is really very simple. But let's just say, for the purposes of
illustration only, that somebody is running a grocery store. The
grocery store has a net income of $200,000.
It doesn't cost
much to hire a manager for a small grocery store, to really replace the
owner of the grocery store. This skill set and the experience is not
that great. You can probably find a really good manager at $60,000 a
year. So if the owner has decided to be the manager of the grocery
store instead, the owner will be entitled to a $60,000 a year salary
and pay self–employment tax on that $60,000 a year. The remaining
$140,000 a year would also be subject to income tax.
Travis:
Oh, through distributions as opposed to salary.
Yosef:
That's right. But he would have to ensure that he actually has payroll
taxes withheld and follows all the other requirements implemented by
the IRS.
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