California CPAs chime in

[mrkun]

I just got an opportunity to do a long term contract/consulting position and I'd like to set up a company to maximize my after-tax income. My thinking is to set up an LLC, and my understanding is that LLCs have the option to have S-Corp tax status. However, I'm not sure if electing S status would be more advantageous or not.

Anyone knowledgeable care to give me some advice?

 

[CPA]

The great thing about setting up an LLC is that for filing purposes you have the option of changing your tax setup. The biggest tax advantage of classifying as an S-Corp versus Sole Proprietorship is that the amount you designate as a distribution is shielded from having to pay Social Security Tax. Just keep in mind that you can't designate $0 wages (100% distribution) in a S-Corp, the wage must be reasonable and you will have to pay the Employee and Employer portion of Social Security Tax on the wage (about 15%). However, if you use the default taxation classification of Sole Proprietorship then you will have to pay the 15% on all income earned.

I am not a California CPA, but the rules are all the same for Federal Taxation. As long as Cali allows S-Corp, then you have the option. And again, if you don't like it, you can change. There is a form, but I don't recall the form number.

 

[mrkun]

Thanks, CPA. What income tax schedule does the distribution follow? Regular wage income tax?

Just as an example for the company:

Revenue = 100k
Wages paid to owner = 40k
Other expenses (e.g. travel expenses) = 5k
-------
Net Income = 55k

So I would pay income tax on 95k, FICA on 40k? What about unemployment tax?

 

[EagleKeeper]

Setup the corp across the state line also

 

[CPA]

Thanks, CPA. What income tax schedule does the distribution follow? Regular wage income tax?

Just as an example for the company:

Revenue = 100k
Wages paid to owner = 40k
Other expenses (e.g. travel expenses) = 5k
-------
Net Income = 55k

So I would pay income tax on 95k, FICA on 40k? What about unemployment tax?

Yes, the wages and distribution would be considered ordinary income. However, you only have to pay FICA on the $40K (like you stated). Unemployment is calculated on wages only, but you will have to pay it.

Here is the IRS page providing you a breakdown of what needs to be paid and filed for a subchapter S.

 

[mrkun]

Setup the corp across the state line also

What's the advantage of that?

 

[paulney]

My wife and I set up a general partnership for her business. General partnership has a pass-through filing: the partnership itself does not pay anything, but the recipients of K-1 done.

Ownership-wise, she holds 51%, so that she gets a women-owned business classification (at least on paper). For tax purposes, the distribution is 99% to me, 1% to her. We file a joint tax return. However, since I have a full-time employment, and clear the Social Security cut-off, at which it stops being collected, everything reported on my K-1 is not taxed for SS any more. And, the taxes my wife has to pay on self-employment are much lower than if she received the full income from her business.

 

[EagleKeeper]

Setup the corp across the state line also

What's the advantage of that?

For Nevada a business friendly climate.

Lower rates and lack of state income tax

 

[sactoking]

After doing a bit of research on my own LLC situation let me offer this counterpoint to CPAs advice to file your LLC as an S-Corp for taxation:

If you file your LLC as a partnership you have to pay self-employment tax on everything the business makes. If you file your LLC as an s-corp you pay self-employment tax on the wages the business pays but not on the dividends. However, under an s-corp filing you do still have to make sure the wages paid are "reasonable", meaning you can't pay yourself a ridiculously low wage to avoid self-employment tax.

EX) Your business nets $100,000. Under a partnership filing you pay 15% SE tax on everything and pay $15,000 in SE tax. Under an s-corp filing you pay yourself a salary of $50,000 and the remining $50,000 is dividends. Here you pay 15% SE tax on the $50,000 salary only and not the $50,000 dividends so your total SE tax bill goes down from $15,000 to $7,500.

The caveat or counterpoint I would offer is that under the s-corp filing any wage/salary amount is subject to Federal unemployment tax, state unemployment tax, and any other local taxes since it is truly "wages". Under the partnership filing many states consider the distribution to be "equity" and not "wages" so you avoid FUTA, SUTA, and other taxes. If your business does not make enough money to exceed a "reasonable" wage or salary under an s-corp filing you will pay unnecessary taxes.

EX) Your business nets $50,000. Under a partnership filing you pay 15% SE tax on everything and pay $7,500 in SE tax. Under an s-corp filing you pay yourself a salary of $50,000 and there is nothing remining in dividends. Here you pay 15% SE tax on the $50,000 salary plus FUTA, SUTA, and other taxes on the $50,000 and realize no SE tax savings.

Here in Nevada the SUTA tax rate is 2.95% on the first 2/3 of an employee's wages up to $26,400. The FUTA rate is 0.6% of the first $7,000 if you pay your SUTA on time. If you're required to pay SUTA you also have to pay MBT (Modified Business Tax) which is 1.17% of wages in excess of $62,500. If you elect s-corp instead of partnership and net $50,000 you'd pay $779 in SUTA and $42 in FUTA ($821 total) in unnecessary taxes.

 

[CPA]

After doing a bit of research on my own LLC situation let me offer this counterpoint to CPAs advice to file your LLC as an S-Corp for taxation:

If you file your LLC as a partnership you have to pay self-employment tax on everything the business makes. If you file your LLC as an s-corp you pay self-employment tax on the wages the business pays but not on the dividends. However, under an s-corp filing you do still have to make sure the wages paid are "reasonable", meaning you can't pay yourself a ridiculously low wage to avoid self-employment tax.

EX) Your business nets $100,000. Under a partnership filing you pay 15% SE tax on everything and pay $15,000 in SE tax. Under an s-corp filing you pay yourself a salary of $50,000 and the remining $50,000 is dividends. Here you pay 15% SE tax on the $50,000 salary only and not the $50,000 dividends so your total SE tax bill goes down from $15,000 to $7,500.

The caveat or counterpoint I would offer is that under the s-corp filing any wage/salary amount is subject to Federal unemployment tax, state unemployment tax, and any other local taxes since it is truly "wages". Under the partnership filing many states consider the distribution to be "equity" and not "wages" so you avoid FUTA, SUTA, and other taxes. If your business does not make enough money to exceed a "reasonable" wage or salary under an s-corp filing you will pay unnecessary taxes.

EX) Your business nets $50,000. Under a partnership filing you pay 15% SE tax on everything and pay $7,500 in SE tax. Under an s-corp filing you pay yourself a salary of $50,000 and there is nothing remining in dividends. Here you pay 15% SE tax on the $50,000 salary plus FUTA, SUTA, and other taxes on the $50,000 and realize no SE tax savings.

Here in Nevada the SUTA tax rate is 2.95% on the first 2/3 of an employee's wages up to $26,400. The FUTA rate is 0.6% of the first $7,000 if you pay your SUTA on time. If you're required to pay SUTA you also have to pay MBT (Modified Business Tax) which is 1.17% of wages in excess of $62,500. If you elect s-corp instead of partnership and net $50,000 you'd pay $779 in SUTA and $42 in FUTA ($821 total) in unnecessary taxes.

I'm not sure you are counterpointing me, just making an argument for a partnership recognition under an LLC that I did not bring up. I didn't bring that up because the OP did not indicate that there would be additional members other than him.

Additionally, Eaglekeeper, my understanding is that in California, as long as the LLC resides in Cali or has a source of income from California, then it will have to pay California taxes and fees. This is regardless if he organizes in Nevada. The annual fee is $800 and the tax is somewhere over 8%. Please correct me if I'm wrong.

EDIT: Here is info from the State of California Franchise Tax Board. Notice the wording is "OR", not "AND".

 

[sactoking]

I'm not sure you are counterpointing me, just making an argument for a partnership recognition under an LLC that I did not bring up. I didn't bring that up because the OP did not indicate that there would be additional members other than him.

Additionally, Eaglekeeper, my understanding is that in California, as long as the LLC resides in Cali or has a source of income from California, then it will have to pay California taxes and fees. This is regardless if he organizes in Nevada. The annual fee is $800 and the tax is somewhere over 8%. Please correct me if I'm wrong.

EDIT: Here is info from the State of California Franchise Tax Board. Notice the wording is "OR", not "AND".

I see what you mean, but if you replace my usage of "partnership" with "proprietorship" wouldn't it be the same? I guess the point of what I meant was that it's my understanding that a single-member or multi-member LLC is better off filing as an S-Corp if the total net income will be in excess of the member(s)' "reasonable salary" but if the net income is close to the "reasonable salary" level then being a disregarded entity is better since you don't pay FUTA, SUTA or other local taxes.

And yes, I agree with you that a Nevada LLC has to pay CA's stupid $800 franchise fee and taxes even if it is organized in another state.

 

[EagleKeeper]

Additionally, Eaglekeeper, my understanding is that in California, as long as the LLC resides in Cali or has a source of income from California, then it will have to pay California taxes and fees. This is regardless if he organizes in Nevada. The annual fee is $800 and the tax is somewhere over 8%. Please correct me if I'm wrong.

Here is info from the State of California Franchise Tax Board. Notice the wording is "OR", not "AND".

form the CA link

If the LLC has a single member, it will be disregarded as separate from its owner, and will be treated as a sole proprietorship or a division of its owner, unless it elects to be taxable as a corporation.

All LLCs classified as corporations that organize in California, register in California, conduct business in California, or receive California source income, must file California Form 100. The California Form 100 must be filed by the 15th day of the 3rd month after the close of the LLC’s taxable year.
The LLC will be taxed at the corporate tax rate of 8.84 percent and will be subject to a minimum tax of $800.

Minimum shafting of $800 of a LLC classified as corporations :'(

This $$ grab by CA only applies to a LLC classified as corporations , not as Sole Proprietor.

Maybe it is best to have an LLC as a parent to a Sole Proprietor; allowing you to use either option.

 

[CPA]

I see what you mean, but if you replace my usage of "partnership" with "proprietorship" wouldn't it be the same? I guess the point of what I meant was that it's my understanding that a single-member or multi-member LLC is better off filing as an S-Corp if the total net income will be in excess of the member(s)' "reasonable salary" but if the net income is close to the "reasonable salary" level then being a disregarded entity is better since you don't pay FUTA, SUTA or other local taxes.

And yes, I agree with you that a Nevada LLC has to pay CA's stupid $800 franchise fee and taxes even if it is organized in another state.

okay, I think I see what you mean. My guess is that in his consulting business, there's not much advantage of him filing as an S-Corp, unless he expects to make hundreds of thousands of dollars.

 

[CPA]

form the CA link



Minimum shafting of $800 of a LLC classified as corporations :'(

This $$ grab by CA only applies to a LLC classified as corporations , not as Sole Proprietor.

Maybe it is best to have an LLC as a parent to a Sole Proprietor; allowing you to use either option.

Right, I was basing him filing as a S-Corp, but you are correct.

The disadvantage of filing as sole proprietorship is that all of the earnings are ordinary income and he will have to pay California state income tax, which may be worse than the Corp tax rate.

 

[sactoking]

form the CA link



Minimum shafting of $800 of a LLC classified as corporations :'(

This $$ grab by CA only applies to a LLC classified as corporations , not as Sole Proprietor.

Maybe it is best to have an LLC as a parent to a Sole Proprietor; allowing you to use either option.

Well, don't forget

All LLCs classified as partnerships or disregarded entities that organize in California, register in California, or conduct business in California, must file California Form 568 Limited Liability Company Return of Income. California Form 568 must be filed by the 15th day of the 4th month after the close of the LLC’s taxable year.
An LLC required to file Form 568 pays an annual tax of $800, and may be subject to an LLC fee based on total income from all sources derived from or attributable to the state of California. The annual tax is due by the 15th day of the 4th month of the taxable year, and is paid using CA Form 3522, Limited Liability Company Tax Voucher.

So they shaft ALL LLCs and not just corporate LLCs.

 

[mrkun]

okay, I think I see what you mean. My guess is that in his consulting business, there's not much advantage of him filing as an S-Corp, unless he expects to make hundreds of thousands of dollars.

The figures I used in my example were about accurate actually. Not making multiple hundreds of thousands yet, but hopefully in the future. /fingers crossed

 

[EagleKeeper]

Move out of CA and give them the tax finger

 

[sactoking]

The figures I used in my example were about accurate actually. Not making multiple hundreds of thousands yet, but hopefully in the future. /fingers crossed

If you're looking at netting $55,000 after paying yourself $40,000, then yes a LLC-S corp combo will probably be best because the Federal and State unemployment you pay on the $40,000 will be less than the ~15% SE tax you'll save on the $55,000.

But Eaglekeeper's advice of just giving them the finger is the best route overall.