Paying Too Much Tax as a Schedule C Self- Employed Business Owner

You work hard 50 to 60 hours per week working and building your business to success and then you are surprised when you find out you owe a “ton” of income taxes, penalty and interest.

It doesn’t have to be that way.
I am talking about what is commonly known as sole proprietorship filed as part of your personal return on Schedule C.  When you are a sole proprietorship Schedule C, your business is neither incorporated (files form 1120 or 1120S) or a partnership (files form 1065).

We recently helped a new client who paid at least $10,500 more in income taxes due primarily to self-employed taxes.
In an S corporation and partnership, only the profits that are paid out as payroll incurs the payroll taxes commonly known as FICA (social security tax) and Medicare. There taxes can be as much as 15.3% of the profit.

So if a business makes $100,000 before paying its owners payroll (known as shareholder for the S corporation and partner for partnership) and pays out only $50,000 to S corporation shareholder as payroll and partnership partner as guaranteed payments, the owners only pay one half of the FICA/Medicare or about $8,000 less in cash!

Where is the “rub”?  If the shareholder or partner takes out more than $50,000 in distributions (for S corporation) or draw (for partnership), the required payroll (shareholder) or guaranteed payments (partners) must be at least the amount of the guaranteed payments.

In addition, S corporations audit rate is .4% while sole proprietorship Schedule C audit rate is as high as 5%! Remember Schedule C’s are part of your individual 1040 tax filing.

Also, there are deductions that are deductible as an S corporation such as office admin expense that are not deductible by a sole proprietorship.  Retirement plan contributions are deductible directly against taxable income on the S corporation but not against taxable income on the sole proprietorship Schedule C.

Like everything, there are advantages and disadvantages. The CPA firm preparation fees to file S corporations and partnerships are higher than the fee of filing your Schedule C as part of your personal tax return 1040.
Unlike a sole proprietorship, you need to use a payroll service to pay your salary.

And unlike a sole proprietorship, you need to in most cases to have a balance sheet as part of the partnership and S corporations.

Balance Sheets are unnecessary for a sole proprietorship Schedule C. Think of the assets on balance sheet as pluses and the liabilities as minuses. The net worth is the difference between the pluses and minuses.

Another disadvantage is that you have to pay state unemployment and federal unemployment taxes on payroll. The owner of a sole proprietor is not considered an employee or a partner so no payroll or guaranteed payments need to be paid. However these taxes are only on the first $7,000 of payroll in most cases and do not amount to much.

The fee to set up an LLC (Limited Liability Company, not corporation or a corporation) can be quite minimal but there is a cost. Normally we establish an LLC and then convert the LLC to a partnership or an S corporation.
A husband and wife can have one LLC or if required by law can establish one LLC than owns 100% of the second LLC so only the first LLC has to file a return. I.E An LLC is required to segregate revenues of a certain enterprises created by law (i.e real estate company, etc).
There is a process we have developed that can be followed to make this process go smooth and it is just a one time investment and process.

© Jeffrey Brooks, CPA 2014

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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JBrooks Wealth Advisors, PC.

Certified Public Accountant
Address: 4647 N 32nd Street, Suite B245
Phoenix, Arizona 85018
Phone: 602-292-2009