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One problem with being self employed

by Scott on June 27, 2009

Many people in our country are self employed. They have taken the road less traveled where they are much more in control of their destiny. Being self employed can be a fantastic way to wealth. It always you to develop a business based on your talents, your passions and your desires in life. A friend of mine referred to being self employed as eating what you kill. You don’t depend on an executive management team to guide you. You don’t have to have a committee meeting to decide which direction your company is going. You get a ton of freedom with being self employed. But you also get to face some difficulties that a normal W-2 employee doesn’t. Consider the case of Smart Passive Income trying to buy a house. His story can be found here.

When you are self employed, the banks and financial institutions consider you to have a less stable income. It doesn’t matter that layoffs from industry can happen at any minute or that the company itself can go belly up leaving you high and dry. There is a way around it though. It will accomplish several objectives at the same time. You can remain self employed and simply deal with the hassles that come with it. I much prefer the other two options. Now they do have some cost associated with them but I think you will find the benefit to greatly outweigh them. Now I am not an expert on these but have done them and worked with customers who have. Each case is unique so please consult with competent tax and legal resources. We are all adults here so treat this as a good starting place to have a conversation with the support team of your business i.e. your accountant, lawyer, tax preparer, etc.

Option 1 – S -Corp You can be incorporated as a chapter S corporation. An easier and usually cheaper way is to form an LLC and file to have it taxed as an S -Corp. You get the simplicity of being an LLC from a paperwork standpoint but being an S-Corp for tax purposes. A S-Corp pays the officers of the company with a paycheck. This is something that an LLC or a self employed person cannot do. For our purposes we will treat an actual S-Corp and an LLC treated as an S-Corp as the same thing. Since an S-Corp pays you with a salary, when you apply to a bank for a loan… guess what? You are employed by a company. Not self employed. You get the advantages of being “self employed” with the benefits of being an employee. Now an S Corp has an additional benefit. This is definitely one you want to check with your squad to make sure you cover all your bases. Let’s say your business generates $60,000 in profits. As a self employed person you pay self employment tax on the entire amount. For those that have never been self employed, when you work for yourself you pay both your portion of Social Security and FICA as well as the companies. This works out to over 15% currently. Now you do get to take a deduction for the portion your company would pay so the math gets a little complicated looking at the savings so I will keep it simple. The amount of Self employemt (SE) tax would be 60,000 *.9235*15.3%= $8477.73. The 0.9235 takes into account the deduction you get for your portion of the SE tax. Remember you still have to pay income tax on your earnings as well.

Now if you are set up as an S Corp and you could hire someone to run your company (Notice I said could not did) for $40,000 a year you can pass the rest of the earnings through without paying SE tax on it. This means you pay yourself a salary of $40,000. You have your portion 7.65% taken out of your check like a normal employee. The company pays its portion of the tax also 7.65% for a total of 15.3%. This leaves $16,940 that will flow through without having to pay SE tax on it. It’s not $20,000 because the company has to pay 7.65% SS/FICA tax on it. This gives you a tax savings of $16,940*0.9235*.1530 = a little less than $2,400. Even paying a professional to do your taxes and your payroll you should come out well ahead.

Being an S-Corp has other benefits as well. Your chances of being audited are lower. The company is separate from you as the individual. So if you get audited, your company doesn’t and if your company gets audited you don’t. It also creates a separate layer of protection for your assets.

If you are currently self employed, please consider the benefits for forming an LLC and getting it taxed as an S Corp. Make sure you discuss this with your squad (accountant, tax preparer, lawyer).

Notice I said Option 1 at the beginning of this article. I will be posting about other ways in later posts so stay tuned. Remember – This is not legal or tax advice. It is simply my understanding of how tax law works today. Make sure you get competent advice in dealing with this. To create a successful business you need a squad to have your back.

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