12 Tax Strategies – Q&A

Diane Kennedy and I just completed a webinar on 12 Tax Strategies for 2013 Tax Savings. The replay is available for a short time over at www.ustaxaid.com/12strategies. Most of the strategies are very time-sensitive, so if you want to move forward, now is the time to contact us.

This week I wanted to talk more about these strategies and answer some of the questions from participants we didn’t get to on the call. If anything you read this week brings on another question, please ask away!

Making Retroactive C or S Corporation Elections

The awesome thing about using an LLC for your business is that you can start it off as a disregarded company and see what happens with your income. The terrible thing about using an LLC like this happens when you make more than you planned, October rolls around, and you realize that you’ve done no tax planning, have made no estimated tax payments and don’t have a lot of time to fix things.

Fortunately, there is a way to offset at least some of the pain, and that’s through making a late tax classification election, changing your tax election from disregarded to either an S Corporation or a C Corporation.

When you make this change, you get to reclassify your income. That means the requirement to pay self-employment tax goes away. It’s replaced by payroll, and payroll taxes. BUT, the cool thing is that you don’t have to take all of your income as payroll. In both the S Corp and C Corp tax structures, you can choose how much is salary and how much is a profit distribution. Only the salary portion is subject to payroll taxes – your Medicare, Social security, etc. The rest is just subject to income tax.

To give you an idea of how powerful this is, here’s a very quick, very rough, very rounded-up calculation. Let’s say you have net taxable income, after all expenses and deductions of $100,000. If that income came through the sale of products or services, you’re going to have income tax to pay, plus self-employment tax of 15.3% on that $100k … which is $15,300. You’ll pay a little less than that, but still expect it to be over $14,000.

If, however, you ran your money through an S Corporation, you could split your income into salary and profit. Salary has payroll tax on it, but profit doesn’t. So a 50-50 split means just $50,000 is now subject to payroll tax … reducing the initial $15,300 to $7,650. Of that amount, half is half is paid by you, and half by your employer … reducing it further to just over $3,800. Are you your employer? Yes, BUT, the employer’s half is a deductible expense to your business. At the end of the date, the calculation is far less than $14,000.

For me, the numbers are pretty compelling as to the why you would want to do this.

For the “how,” as in “how do I do that,” you need to do 2 things: make your late S or C Corporation election and get your payroll set up before the end of December.

To make the election, you need to complete the appropriate form, which is a 2553 for S Corp elections and an 8832 for C Corp elections and send it in to the IRS. Get your CPA or other tax advisor to help you with this. There are no real downloadable forms with the right language for late elections and the more time you spend trying to figure it out, the less time you have to take care of the second part – getting your payroll set up and getting your accounting records in order.

For payroll, again, I’d look to the professionals for quicker service. Payroll is a minefield of deductions, tax rates, etc., and while you can do it yourself, it might make you a little crazy, and it will absolutely slow your down. Plus if you’re going for the S Corp election you may be running a whole year’s worth of payroll at a single time, which is different from a regular, established bi-weekly or monthly payroll.

Making a late election won’t take away your tax bill, but it will certainly help to lower it.

Question: Regarding Retroactive Election strategy, does it allow me to take a sole proprietorship and reclassify to a new LLC taxed as an S-Corp for 2013?

Answer: No. You have to incorporate a company or form an LLC first. You can’t make an election if your business is an unincorporated Schedule C Sole Proprietorship business.

Question: We formed our LLC in July. We were told to file 8832 Entity Classification Election to ask the tax year ending of our LLC by December 31. 

Answer: Form 8832 is the document you use to make a C Corporation election for your LLC. It’s supposed to be filed within 75 days of your formation date. If you are outside that date, the Form 8832 needs to be completed a little differently, to make a late election. You may not need to do it by December 31st, but you MUST do it before the first tax return is filed.

One thing to note: a Form 8832 election does not allow you to change your fiscal year-end. Remember, C Corps can pick a date other than 12/31. That is done by filing your first year’s tax return.

At Smart Business Incorporation, we specialize in helping investors and business owners develop structures to run their businesses, protect their assets and keep as much of their earnings as possible. If you want to know how to best structure your next business, visit our website or drop us an email at info@smartbusinessincorporation.com. We’ll be glad to help.

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