Self Employment

Jeff Schroeder jeff at neobox.net
Thu Jul 21 10:18:31 MDT 2005


Kimball wrote:

> 15ish% = raw income tax
> 15ish% more = Other federal things: Social security, FICA, etc, etc,
>
> Now, if you set up an S-Corp, the "Other federal things" category  
> goes away - ie, you pay about 15% less in taxes.

I'm not sure who your accountant is, but this information is incorrect 
(or else I completely misunderstand you).

You can't escape the income tax, it's true... you pay that on your 1040 
at the end of the year for all the money you've earned-- both at your 
"regular" job and any side jobs you have.  But an S corporation 
definitely pays SSA, FICA, unemployment insurance, filing fees, and so 
on.  If you pay yourself via the corporation and take out payroll 
taxes, for every dollar of Social Security tax you report on your 1040, 
your company is paying a matching dollar.  6.2% of your income goes to 
the SSA from your paycheck, and another 6.2% comes from your company.

Thus, I don't understand how you can say the "other federal things" go 
away with an S corporation.  Perhaps you're referring to paying 
EVERYTHING as dividends, rather than payroll?  That's certainly 
possible, but leads to two issues:

1) Since dividends are taxed differently (e.g., no SSA), the IRS keeps 
an eye on companies that pay large dividends but small salaries.  In 
other words, if you've earned $30k and pay $25k in dividends, that's an 
immediate "red flag" because the remaining $5k "salary" is clearly 
unreasonable for the work you're doing.  Hello, Mr. Auditor!

2) Any dividends you receive will be taxed on your 1040 as part of your 
AGI, and will also be reported by the corporation on form K-1 as 
profits.  As a shareholder of the corporation, you will be taxed on 
those profits.

> Now, since you are going to be running this corp from your home, you
>   can expense a portion of your dwelling as office space, and "rent"
> it to yourself from the corp.

Yes, but once you designate a part of your house for business use, a lot 
of interesting things happen.  You *must* use that area exclusively for 
business 80% of the time (or something like that), you have to 
calculate crazy things like percentages of utility bills (how much 
electricity does your office use compared to the rest of the house?), 
and IIRC it creates some weird situations when you sell your house.

My advice-- backed up by the advice of several realtors and my 
accountant-- is that writing off business use of your house isn't 
generally worth the hassle.  YMMV.

> Further, any other expenses you can 
> dream up for your corp will avoid the 15% of raw income tax, and you
> get all that money to be used tax free.

That's true.  The general rule is to expense everything you can, of 
course with an eye toward being honest.  I've known people who write 
off their vacations because when they were in Aruba they happened to 
mention to some guy at the bar that they run a software company or 
something.  "Hey, that's a business conversation, so I can write off 
the whole trip!"  Let your conscience be your guide, remembering that 
if you're ever audited you're going to have to justify that expense or 
face back payments and some nasty interest.

I'm not an accountant, nor a lawyer-- I'm just a Linux geek who owns 
several S corporations.  So don't take my words here as gospel, but be 
aware that the tax laws are FAR more complicated than they might seem 
at first.  Also, I'm not slamming Kimball's statements, because I might 
be misinterpreting what he said, but before you trust a bunch of Linux 
geeks I'd go to an accountant and get the real story. :)  In my 
experience, accountants are willing to give you a free one-hour (or so) 
"consultation" where you can ask this kind of stuff, in hopes that they 
get your business in the future.  It would be worth asking.

$0.02,
Jeff
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