Self Employment

[Kimball Larsen]

On Jul 21, 2005, at 10:18 AM, Jeff Schroeder wrote:

> 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:
>

Sort of - accountant calls it an "Owner Draw", not salary, not a  
dividend.  In my situation, it works ok, as my corp is not making  
anywhere near what Hans will be pulling in here, and I am able to  
expense a large portion of the corp income (without running into the  
moral complications you mention below)

> 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.
>

True, but I wanted Hans to know it is possible.

>
>> 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.
>


I totally agree with Jeff here.  I am also just a skinny little  
programmer - no accountant.  I can barely add.  I've just related in  
broad strokes what works for my situation in the hopes that someone  
out there will find is useful.

Please consult with a professional accountant before doing anything  
with any real money.


-- Kimball