Solo Agent: Sole Propietor, Corporation, or LLC?

[MW Agent]

I wrote this recently for another source, thought I would share it. Some of you may find it helpful:

Solo Agent: Sole Propietor, Corporation, or LLC?

This is a common question many agents have as it relates to the tax advantages. First things first: If you are getting off the ground, you should be spending your time finding new clients, not worrying about which business entity to choose. As your business matures and you start to become profitable, that is typically the time to start digging deeper. Below is a quick overview of each. Of course, this is a general outline, the devil is always in the details as each situation can be different:

Sole Proprietor: If your net income is under $35,000 per year, this is likely the best option when all things are considered. While you could incorporate, there are additional costs that go with it such as: W-2 payroll compliance reporting, filing Form 1120 or 1120S, K-1 filing, and you need to be more diligent in keeping your books (which you should be doing anyway). A good tax accountant can do that for you, but you are likely looking at an all in cost of at least $1,000 to $1,500 per year.

S-Corporation: If your net income is somewhere in the $40,000 to $200,000 range, it's likely an S-Corp could spell enough tax savings to make it worth the compliance costs. The advantage of an S-Corp is that you can divide your wages into two components: 1.) W-2 compensation as an employee of your corporation that is subject to FICA taxes (Social Security/Medicare). 2.) K-1 income as the owner of the corporation that is not subject to FICA taxes.

Let's do some math as an example, let's say you are netting $70,000 per year as a sole proprietor. You can justify a wage of $40,000 from your corporation (more on this in a later edition). That means the balance of $30,000 would not be subject to FICA taxes (15.3%). $30,000 X 15.3% = $4,590 in savings (it's actually a little less, but I won't go into it for this post). $4,590 - $1,200 in compliance costs = $3,390 in immediate tax savings. You can spend it, invest it in your business, or super charge your savings even further. How you might ask?

Putting it into a tax qualified retirement plan. For example, if you put the $3,390 into a SEP IRA and you are in the 25% federal bracket, that's an additional $847 in tax savings for a total of $4,237. If you are in a state that has an income tax, there would be even more savings.

C-Corporation: As a general rule, once your income gets to be north of $200,000 to $250,000, it may make sense as some point to look at a C-Corp. As your W-2 income goes above the Social Security wage limit of $118,500 (in 2016), the S-Corp loses some of it's attraction (although you still save on the Medicare taxation which is not capped). The C-Corp design allows owners some additional tax deductions that the S-Corp does not, which means at a higher income amount those deductions may prove to be valuable enough to make the switch.

But wait, you didn't mention an LLC???

From the IRS's perspective, the LLC is a disregarded entity. That means that it can be taxed as any of the three options listed above. If you don't make any sort of election, by default, it's considered to be taxed as a sole proprietorship and you file a Schedule C return. If you elect to be taxed as a corporation, you file a Form 1120 (C Corp) or 1120S (S Corp). Why would a sole proprietor form an LLC?

The main argument most make is legal protection. While you should consult an attorney as I don't give legal advice, others in the industry have told me that a solo agent really doesn't have much legal protection against errors and omissions regardless of the entity. Are there other reasons? Yes, there can be some state specific reasons in a handful of states.

 

[Chazm]

Thanks for the info.

I can't figure out why but I've talked to two accountants and they both have said I shouldn't Incorporate. I fall in the guidelines that you mention one should Inc but they told me that there wouldn't be much, if any tax savings after paying payroll taxes, unemployment, accountant fees etc.

Maybe they aren't thinking that I would pay myself, like in your example, a $40k salary and then the remainder 30k....wait that's where I get lost. Why is the remainder $30k not exposed to FICA again?

 

[pfg1]

Nice job. Is there somewhere I can read the whole article?

 

[WCMason]

Thanks for the info. I can't figure out why but I've talked to two accountants and they both have said I shouldn't Incorporate. I fall in the guidelines that you mention one should Inc but they told me that there wouldn't be much, if any tax savings after paying payroll taxes, unemployment, accountant fees etc. Maybe they aren't thinking that I would pay myself, like in your example, a $40k salary and then the remainder 30k....wait that's where I get lost. Why is the remainder $30k not exposed to FICA again?

The remainder is profit, not salary, so subject to income tax but not FICA.

 

[Chazm]

The remainder is profit, not salary, so subject to income tax but not FICA.

Ok great thanks. I'll mention it to my tax lady and try to figure out why I'm constantly told it's not worth it for me

 

[MW Agent]

Thanks for the info.

I can't figure out why but I've talked to two accountants and they both have said I shouldn't Incorporate. I fall in the guidelines that you mention one should Inc but they told me that there wouldn't be much, if any tax savings after paying payroll taxes, unemployment, accountant fees etc.

Maybe they aren't thinking that I would pay myself, like in your example, a $40k salary and then the remainder 30k....wait that's where I get lost. Why is the remainder $30k not exposed to FICA again?

To be fair, let me be a little more precise on those figures as the above article was to show the general concept:

$30,000 K-1 (not subject to FICA) X 14.13% (because half the self employment tax is deductible as an above the line deduction) = $4,239 savings. Minus federal FUTA of $430 (first 6% to $7,000 in income) = $3,809. Minus out the accounting costs of $1,200 per year (I use that number because that's what I charge for payroll and tax compliance) = $2,609 for that example.

Toss it all in a SEP IRA at the 25% bracket and it's a $3,261. Add in state taxes in my home state (7%) and it goes to $3,443. If you factor in that your tax lady is likely charging to extra already to file the Schedule C beyond just a traditional 1040 return, you can add the marginal cost onto that number as well.

One thing to keep in mind is that when you pay less FICA into the system, you are lowering your future Social Security Benefit level. That's why I'm such an advocate of throwing the savings into a SEP IRA (or similar vehicle). When I ran the benefit analysis of the SEP vs Social Security Benefit reduction for a client recently, the SEP had to beat a 0% real return over a period of 30 years for the client to come out ahead.

----------

Nice job. Is there somewhere I can read the whole article?

Thanks for asking. It was a blog post, that was the entire post. I started a tax blog geared to insurance agents (both agent issues and client issues), my plan is to post once per week early on Friday or Saturday morning. There is a lot of info out there I wish I would have known a lot earlier in the business.

 

[sirherbie]

Yes but if your maxing out at over $118K after the writeoff and in your late 40's or early 50's then a non sep is better. In 10-12 yrs you just can't make up the tax savings up you get in a non Roth

 

[kuhn123]

To be fair, let me be a little more precise on those figures as the above article was to show the general concept: $30,000 K-1 (not subject to FICA) X 14.13% (because half the self employment tax is deductible as an above the line deduction) = $4,239 savings. Minus federal FUTA of $430 (first 6% to $7,000 in income) = $3,809. Minus out the accounting costs of $1,200 per year (I use that number because that's what I charge for payroll and tax compliance) = $2,609 for that example. Toss it all in a SEP IRA at the 25% bracket and it's a $3,261. Add in state taxes in my home state (7%) and it goes to $3,443. If you factor in that your tax lady is likely charging to extra already to file the Schedule C beyond just a traditional 1040 return, you can add the marginal cost onto that number as well. One thing to keep in mind is that when you pay less FICA into the system, you are lowering your future Social Security Benefit level. That's why I'm such an advocate of throwing the savings into a SEP IRA (or similar vehicle). When I ran the benefit analysis of the SEP vs Social Security Benefit reduction for a client recently, the SEP had to beat a 0% real return over a period of 30 years for the client to come out ahead. ---------- Thanks for asking. It was a blog post, that was the entire post. I started a tax blog geared to insurance agents (both agent issues and client issues), my plan is to post once per week early on Friday or Saturday morning. There is a lot of info out there I wish I would have known a lot earlier in the business.

What's the address of your blog?

 

[sirherbie]

what would be the difference in setting up a sub chapter S vs setting up a LLC with a sub chapter s election? I've read an agent that gets paid as an Llc doesn't have to get licensed as a llc with the state. Getting paid as an Sub chapter S don't you have to get licensed with the state?

 

[Newby]

what would be the difference in setting up a sub chapter S vs setting up a LLC with a sub chapter s election? I've read an agent that gets paid as an Llc doesn't have to get licensed as a llc with the state. Getting paid as an Sub chapter S don't you have to get licensed with the state?

FexContractng is an LLC and we have to license on all the same states as an SCorp. It's a pain to keep up with too.