Discussion:Best way to maximize deductions

How about inc'ing the biz, reducing her SE income to the reasonable salary level, and then buying the loft for office use, personally, taking rent out of the corp, etc. Then, her solo 401k number just went to 25% of salary plus the deferral amount.

These are based on 2007 numbers, so they may have changed a bit. But the bottom line, as I read it, is there's no real benefit to one over the other in my client's case. On the other hand, if the self employment earnings were small and provided a secondary income, then the Solo 401K would be more attractive because you'd be able to contribute a lot more to it (because the first $15,500 contributed would not be limited to 20% of income).

I think the most important thing here is deciding whether 'one swallow makes a summer' in that once the loft is purchased, will business prospects continue as now. And don't use the argument that the real estate can be sold if business falls. Have a photographer client who bought a loft in a similar situation 6-7 years ago and now is moving into it to cut his living costs since his residence will be easier to sell in a buyer's market.

Thanks for the thought--it's an important point to consider. In this particular case, the business is about 10 years old and continues to grow despite economic times, unlike some photographers I have as clients (one now deliver pizza at night to generate extra income, given the downturn in advertising and marketing revenues for him, even though his photography business is also about 10 years old). Appreciate everyone's input--exactly what I was hoping for.

Of course, given his sales are 1 Million plus, he/she will fall in to the new administration's 125% tax bracket in future years so there would be potential for a 25% savings. That'd be if the new administration didn't begin phase out of all business deductions once a company hits $17,500 of gross income! BWA-HA-HA that should start a fight there! :D

Michael

Just note that while not a bad idea, the owner better make very good and sure he/she comes up with a reasonable salary that the IRS will buy. Even during the Bush administration, S corporation reclassifications were taking up a lot of the IRS's time. I would imagine that the tax everything that moves perspective of the obama administration and the feeling that only 'rich' people use S corporations to avoid SECA taxes, that will increase.

I would think--no verification of this--that transitioning a successful business from a SMLLC to S Corporation would just scream AUDIT ME! RECLASSIFY ME! CASTRATE ME! :D I would also think that a business owner with a history of being taxed on a very large income is going to have a tough time satisfying the IRS that $50,000 or even $100,000 or even $250,000 is a reasonable income. Remember reasonable in this case is the IRS's reasonable not ours.

Be careful of this option and be sure it is bulletproof.

Michael

I don't see anything wrong with incorporating. I think I would go for it (if I hit the $1 million mark). I am very cautious, and I don't see a big red flag here.

Try that first to see if it works out for the client before purchasing real estate.

No, I wasn't saying incorporating was wrong...just that it would raise eyebrows in the IRS. Maybe an audit and maybe not.

Let's say this million dollar man/woman flows through $750,000 in net income from schedule C for a couple of years and pays SECA on that amount. Then, let's say that same taxpayer suddenly incorporates as an S Corporation and flows through the same $750,000 but only pays SECA on $500,000 of the $750,000 because he/she pays themself a $250,000 salary. While there is nothing technically wrong with that, the IRS may raise an eyebrow and take a look.

I read an article pre-election that the IRS was devoting a significant percentage of its workforce to challenge S Corporations salary allocations. Why? Because dollar for dollar, this happens to be one of the more abused tax shelters and a great place to raise tax revenue, interest, and penalties. Just like the police that hide in bushes who are only concerned with safety, the IRS is only concerned with compliance--not the tax revenue resulting from it! You have plumbers who would otherwise make $75,000 as an employee paying himself $20,000 and taking the rest as a distribution. I would imagine that post-election, with the war on the 'rich', audits and reclassification will only get worse.

I see a lot of software consultants who are doing well using S Corporations and they usually win. That's because there are any number of a thousand places where an owner can show what they would make in salary based on the going rate. Other professions are not so easy to peg and as always the IRS has the last word unless the taxpayer has the funds and energy to take it to tax court.

Michael

Michael

Lots to chew on here.

Nor do I often fall prey to much of the palaver that the search engines serve up now.

But, it obviously pays.

(nor any less)

When I first started I found a self-employed plumber that was just about this smart <->. He worked for a plumbing company but wanted to start an S corp plumbing business of his own. Being hungry and this my first nibble, I learned everything I could in anticipation of that meeting. Drove over on a SUNDAY no less to meet him and the wife.

The wife was a shrill, no better word for it. Not nice. Not happy that husband had brought someone in to talk. Just not happy.

I learned more about their situation....he wanted to create an S corp for a part-time after hours business he started for supplemental income. The anticipated yearly REVENUE was $5,000 or so. After expenses, maybe $2K. I almost laughed until I realized they were not kidding. I went over the problems (no FICA savings because it would ALL be considered salary), additional costs to incorporate, increased IRS filings, corporate meeting, additional returns, etc. You could see the light go on in the dude's head but the wife just seemed to get madder. Finally the guy almost ended up yelling at the wife that this was going to cost them a fortune! :D

I just told them all the reasons and I told the guy "good luck" as I glanced at the wife, smiled and was off.

What a complete doofus. I bet that if he incorporated, he spent every bit of his net income in S corp costs.

Michael

By the way, that Franchise tax 'trap' can infect MMLLCs in Pennsylvania too unless profits are drained by guaranteed salaries. And then there can be local taxes that suddenly take savings into deficits.