Businesses today are driven by numbers – how much time you are spending with your clients, how much you are charging them per hour, how you can leverage time to get the best returns without having to do mountains of administrative work. One of the most prominent areas where business owners have a lack of understanding and leave money on the table is TAXES.
How do you know if you are paying too much in taxes? Do you feel like there is a disconnect between what is on your financial statements and what is actually in your bank account? Maybe your financial statements say that you made $1,000,000, but you only paid yourself $100,000, and you owe the IRS $100,000. You’re not really sure how that happened or what course of action to take. Have you had a conversation lately with your CPA so you know exactly what is tax deductible and what is not?
There are over one million articles on Google for “the best way to structure a law firm.” There are over three million articles on “ways to legally avoid taxes.” If you really want to minimize your tax burden, the best option is to find a CPA that will educate you and work with you on a regular basis to set up the correct business structure and help you understand the tax implications of everyday decisions.
You should be speaking to your CPA firm at a bare minimum of once a month, so you know exactly where you stand. This will ensure that you have the right information to make the right decisions that will drive your business forward and avoid making unnecessary mistakes.
There are 5 major things to look for when implementing a tax strategy:
- The type of entity you are structured in – LLC, S Corporation, Partnership or C Corporation. This is how the bulk of the cash is going to be taxed depending on the structure.
- The second layer is return of capital – how you get paid as the owner of the business. There are salaries, dividends, distributions and guaranteed payments all applied in different types of entities, as the tax structure is different for each.
- Retirement planning reduces current day liability and allows funds to grow tax deferred for shareholders.
- Fringe benefits for employees and owners – salary excluded benefits for both employees and owners which are also tax deductible to the owners company.
- Strategic reinvestment for the company – qualified business deductions and expenditures that businesses can use to grow their business. For example, hiring a marketing person when targeting organic growth or even acquiring another firm.
One of my clients was a very typical small law firm. The owner had organized it as a Single-Member LLC. He structured the business that way because one of his colleagues told him that was the best way to start. Once the business started growing, other people told him that he should be structured as an S Corporation. He had a very long list of questions for me that included:
- Will I pay less in taxes?
- Does it cost more to be a corporation or an LLC?
- Does my wife get the business if I’m hit by a bus?
- What’s the best retirement tool – IRA, SEP, or 401K?
- Are you charging me for this conversation?
- What else don’t I know?
Here are some of the biggest advantages and disadvantages of structuring a small company as an S Corp.:
The Self-Employment tax is made up of Social Security and Medicare taxes. Owners of S Corporations incur these taxes only on the portion of salary that they pay themselves. The net income flowing through to the owner after this salary deduction is not subject to these taxes. In an LLC structure, all net income allocations are generally subject to Self-Employment taxes.
the net income from an S Corporation is not taxed at the corporate level. The net income “flows through” to the shareholders where they are taxed only once at the shareholder’s marginal tax rates.
many times the costs of compliance for single shareholder S Corporations are higher than those for Single-Member LLCs. Unlike SMLLCs all S Corporations must file a separate annual income tax return, for which a CPA will need to be hired to prepare. Additionally, all owner operators of S Corporations must be on payroll, for which a payroll company will need to be hired to process. Owners of SMLLCs with no other workers other than themselves may not have to hire a payroll company. Hiring these outside parties has a monetary cost.
profits, losses and distributions must be allocated in accordance with shareholder capital ownership percentages when structured as an S Corporation. This is not a problem for Single-Owner S Corp, but when there are multiple shareholders it can be a pain. Within the LLC structure profit, loss, and distribution allocation don’t necessarily have to match capital ownership percentages. It depends many times on how the Operating Agreement is written.
A good rule of thumb is that if you have more than $65,000 in net income, you should begin discussing the benefits of an S Corp versus an LLC with your CPA
We converted this client to an S Corp. We also helped him determine how much he should be reinvesting into the business versus saving in a retirement plan. In the first year this client worked with us, his tax bill was cut by 33%. We expect similar results for year two.
If you are an attorney and you want more detailed info about how to minimize taxes and maximize profits, check out this free digital book entitled "Accounting for Attorneys: How to minimize taxes, maximize profits and create more time for the things you love"
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided in this website is not all inclusive and such information should not be relied upon as being all inclusive.