This is the second post in a four part series focusing on business and incorporation strategies for Real Estate Professionals.
If an employer offered you a 5% raise tomorrow, I imagine that you’d be pretty tickled. If that’s the case, the advice I’m going to give in this post will be the equivalent of a feather in your ear or a finger in your side... Sometimes the fastest route to increasing your income is to decrease your tax liability. Since I can’t recall ever encountering a taxpayer who thought they were under-taxed, I imagine this topic will have universal appeal.
There has been a lot of Washingtonian hoopla regarding the tax cuts over the last several years. However, there has been a silent tax increase that has far-reaching impact and has gone relatively unnoticed (my partner, Garrett Sutton, posted on this very topic last week).
The silent tax increase is the payroll tax, which is the tax collected to fund the bankrupt Social Security program and Medicare. If you are under 40, you probably already realize that this ponzi scheme has very little chance of yielding a return on your contributions when you retire. Many of you may discover that you pay more of this tax than any other.
If you receive a W-2 as an employee, you’ll notice that your total contribution amounts to 7.65% of your gross income (you don’t get to see that your employer is paying a matching contribution – if only your employer was as generous with your 401(k) you’d be retired already!). If you are an independent contractor – operating as a sole proprietor, you have the privilege of paying 15.3% of your income. Hefty indeed. So let’s talk about how you can take advantage of a legal remedy to this income sucker.
In my last post, I discussed the importance of setting up a corporation. I recommended an S-Corporation, which is a pass-through entity, meaning that at the end of the year all profits from the business pass through to your individual tax return as a distribution – where you will pay income taxes only. You only pay the welfare tax on your wages.
So assume you earn $100,000 this year. Operating as a sole proprietor you will pay $15,300 in payroll taxes. Now let's assume you have set-up an S-Corp set-up and you feel a salary of $30,000/yr is reasonable.[The operative word here is "reasonable" - you don't need to pay yourself at the top of the pay scale, but the IRS requires the salary to be reasonable. PayScale.com will give you and your tax planner an idea of what is a reasonable amount for you.]
The $30,000 is subject to the 15.3% tax, meaning that you will pay $4,590 in payroll taxes. The $70,000 that remains in the business will flow through to you as a distribution – taxed at your income tax rate.
This simple strategy would save you $10,710 ($15,300 - $4,590) and leave you more money to grow your business or to reward yourself for your efforts.
Now that we’ve covered off on the tax benefits of incorporating, in my next post I’ll turn the attention to accessing capital for your business.