Bert Seither is a certified SCORE mentor. He's also Vice President at 1-800-Accountant, which is a national accounting and business development firm. For over a decade, Seither has assisted thousands of startups and well-established small businesses with business development needs. He has gained the knowledge of tax reduction strategies, compliance, bookkeeping, payroll, and business planning. He has been featured in expert interviews on television networks such as ABC, NBC, and Fox. Seither is a graduate of the University of Florida.
Bert, why should taxes be a concern for a small business owner?
That's a great question. Of course taxes probably makes most people cringe when they hear the word. It's something that either you can approach head on and really tackle, and if you do, you can actually pay your fair share and not a penny more in taxes. It's just one of those inevitables of life that we have to address. I think most people don't realize that for, depending on the resource, 8 or 9 out of 10 people in the United States actually pay more out in taxes annually than any other expense, more so than our mortgage payments, rent, food, insurance, groceries, what have you.
The question should be not just how much money am I making but how much money am I actually keeping. Over the years, I've found that not a lot of people think like that initially when they're starting a business. After they've been in business a while, they realize they're stroking checks to Uncle Sam. Then it's time to do something.
Didn't one of the Supreme Court justices say that is the taxpayer's right to pay as little taxes as possible?
Yeah, more or less. Many, many decades ago, Supreme Court Justice George Sutherland found in a ruling that's actually still honored today that it is the right of the American taxpayer to decrease what would be their tax bill or, and I almost quote, avoid their taxes altogether, by which means the law permits cannot be avoided. Yes, we can pay our fair share and not a penny more, as long as we're following the law. It's all about understanding the tax law and what our options are.
Different forms of businesses will inevitably lead to different tax structures. What type of legal structures or entities should a new business owner consider?
Great question. While I'm not an attorney, and I don't want anyone to think I'm giving them direct legal advice because we're just doing this show today, there's a lot of options. Initially I found that a lot of people end up doing nothing at first, meaning they're a sole proprietorship by default. I think they tend to do that because it's probably the easiest to do, to get started in running a business.
In the long run, it could end up being the most costly. Of course it doesn't cost anything to set up a sole proprietorship, but when we are a sole proprietorship, our taxes actually get really, really high, depending on what state you're listening in. Of course you may have state income taxes, federal income taxes. Then you have self-employment tax on top of that, which is currently levied at 15.3 percent. It can leave you scratching your head at the end of the year saying, "What happened to all my money" when you're paying 30, 40 percent or maybe even higher out to taxes. Yes, there are other options, things like an LLC.
LLCs tend to be very common with business owners these days. S Corporations as well, especially for small businesses. There's really not a one size fits all approach. If your neighbor has the same type of business that you have and they have a certain entity structure, that does not mean that you should follow suit in doing the same thing. Definitely get some legal or tax advice when setting it up. Yeah, the LLC is a very, very flexible entity because it's got the least amount of paperwork involved. You don't have to have corporate minutes and meetings and what not as you would with say a corporation. It's sort of known as the hybrid entity.
It's actually a cross between a sole proprietorship and a corporation. The interesting part, it does not come with an inherent tax structure. You actually get to set it up or build it. What I mean by that is we actually get to choose which set of tax forms we prepare our LLC's taxes on at the end of the year. The interesting part about it is you don't choose at the end of the year, when it's time to file your LLC's taxes. You actually choose in the beginning. It actually has to be done within 75 days of forming your LLC. You do this by making what's called an entity classification election. It's a mouthful.
Does that only occur once or could you change your tax structure of your LLC during the existence of the LLC?
Phenomenal question. You can change but, once you pick something, you have to stick with it for 5 years. Now if you've actually missed that 75 day window, which I found a lot of people have because they just didn't know that they had an option, then you can actually, there's a revenue procedure, rev proc (procedure) that can be done to change it between January 1st and March 15th of the following year. Basically by doing so with the LLC and making an entity classification election, we see it most common where small business owners will elect to be taxed as an S Corporation.
I want to be clear. That does not mean that you're actually setting up an S Corporation. You're always an LLC. You have the phenomenal benefits of asset protection, liability, et cetera, but you can get the tax benefits of a corporation. It's all about the reduction of self-employment taxes. That's a little bit about the LLC. The S Corporation, it's another very, very common structure because it is a pass through structure, meaning we're not having to deal with the double taxation that a C Corporation would bring to us. With the S Corporation, there are basically 2 ways that we can take money out of the business.
We have to pay ourselves what's known as a "fair and reasonable salary." That would be you, even if it was just a one owner S Corporation. You would actually be an employee of your company and have a W-2 from your company come the end of the year. Your company is actually paying half of those taxes for you, which is a deduction for the company. Then you pay the other portion. A lot of the money, and a fair ballpark is about 50 percent, can actually be distributed to you via a K-1 form. The beautiful thing about this is there are no self-employment taxes at all on any money that's distributed via a K-1.
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