Hi all, I have a question about forming a s-corp for work I completed as a sole proprietor. I do some short term consulting work that is similar in structure to locums work (learned about locums through my physician spouse), so I thought you all might have some ideas.
I performed about $35k of services earlier this year for a contract, and will likely line up another $75k of similar work this year.
Unfortunately, I signed a contract and performed the work for the first $35k as a sole proprietor. I intend to form a s-corp for the remaining work so I can save some on SE-taxes (plus solo-401k benefits vis-a-vis 199a).
Normally, I would think that it is too late and that I need to recognize the $35k on schedule C and pay SE-taxes on the full amount.
However, there are three wrinkles that make me think that I *might* get to run that $35k through a new s-corp:
1) I have not yet been paid for that work, nor set up as a vendor in the client’s payment system
2) My contract includes language allowing me to assign my rights subject to client’s written approval
3) The client is willing to give me written approval to assign rights to a S-corp, which I would form now and also use for future work for this client.
My thinking is that if I form a S-corp, assign the rights to the contract, and collect the payment via the s-corp I can save on SE-taxes for about $10k of that $35k, plus defer $7k of that $35k as profit sharing contribution to a solo 401k, saving me SE-taxes on that amount as well. Yes, it will all reduce my QBI-deduction, but on balance the SE-tax savings is much stronger. Normally, I wouldn’t worry too much about saving 15% of $17k. But since I will be forming my S-corp anyways, there is minimal extra work.
So my questions: Does this seem possible? Can I assign my rights to get paid from my sole-proprietorship work to a s-corp that I form after the work is complete but before I get paid? That way the client records the payments as going to the s-corp and it is the s-corp that makes the profit?June 5, 2019 at 3:57 pm MST #219477PedsParticipantStatus: PhysicianPosts: 3787Joined: 01/08/2016
The first question is do you even need a scorp?June 5, 2019 at 4:04 pm MST #219480
Need vs. benefit from.
I would benefit from it. With only a max $105k in earned income during the year, every $100 of profit I take as a distribution would save me $15.30 of SE-taxes. That would more than offset any loss of QBI deduction. If I apply a “safe harbor”* (*=roughly, semi-officially) approach of 60% of the $105 in wages, it would still save me 15.3%*$42,000 = $6400 in SE-taxes.June 5, 2019 at 4:15 pm MST #219486
Agree with peds
An S Corp is usually counterproductive and more costly for side income work, in terms of taxes
Do you have a regular job and if so what is your salary there?
In the rest of my time I do real estate investment. None of it is subject to FICA taxes. That would not get run through the s-corp.
The main idea here is to potentially save on SE-taxes since I don’t pay FICA anywhere else.
edit: a few words.June 5, 2019 at 4:18 pm MST #219490
If you have no other wages then yes an S Corp can save on FICA taxes. I won’t comment on your “safe harbor” approach to wages.
But you also have to factor in accounting costs. Filing of the 1120S. Doing your own payroll? Potentially state level additional entity taxes or fees not applicable to a sole prop.
And, your solo 401k contributions would end up lower as an S Corp because the contribution figures are based on compensation. And distributions do not count toward compensation.
I agree there is some additional complication, but the work essentially pays $25k per month, just a few months a year with only me as the employee, so payroll costs (time + money) won’t be major.
State annual fees are $100 per year with no additional entity taxes. Locally, I’d pay the business taxes as either sole prop or s-corp.
It is a services business, so costs = payroll + some software licenses. Pretty simple accounting.
I agree that employer solo-401k contributions would be lower (limited to 25% of employee comp). But since they would reduce QBI anyway I don’t mourn the loss too badly as I could still fill up ~$34k of the 401k limit (19k employee + 15k employer) + $6k backdoor roth. Nothing wrong with taxable accounts available for real estate or other long term investments.June 5, 2019 at 4:31 pm MST #219498
It sounds like you have a good handle on the numbers. I don’t know the answer to the question of “too late” or not. I suppose one more thing to consider would be lifetime social security. If you have irregular earned income, you might want to see where you’re at and where you project to be with respect to lifetime credits and the bend points. It’s something I have very little understanding of, but may be worth a few hours of your time learning about.
thanks, that’s a good point about the lifetime social security. (Un?)Fortunately, I maxed out soc sec for a few years of peak earnings, so I am already a third of the way from the first toward the second bend point even though I am still in my thirties (an advantage of not delaying earnings due to med school).
I think that the ROI so many years out from collecting at 70 is pretty low, especially compared to alternative uses of that cash (e.g., long term investments compounding for 35 years). But I will take another look at it.
If you want a sweet place to learn about the lifetime social security benefits and potential benefit amounts check out https://socialsecurity.tools/app.htmlJune 5, 2019 at 5:08 pm MST #219509spiritriderParticipantStatus: Small Business OwnerPosts: 1750Joined: 02/01/2016
I intend to form a s-corp for the remaining work so I can save some on SE-taxes (plus solo-401k benefits vis-a-vis 199a).Click to expand…
The key information requested by @jacoavlu (any other W-2 wages) is critical. It could actually be that you will pay more in FICA taxes as an S-Corp than you would SE taxes as a sole proprietor. Please answer this question.
A sole proprietorship and an S-Corp can both adopt, maintain and make employee elective contributions to a one-participant 401k. A sole proprietor’s maximum employer contributions is 20% of their self-employed earned income (business profit – 1/2 SE tax). An S-Corp 2% shareholder-employees maximum employer contributions is 25% of their W-2 Box 1 wages. Generally a sole proprietor can make a larger employer contribution than an S-Corp 2% shareholder-employee.
A sole proprietor and an S-Corp 2% shareholder-employee can both both claim the QBI deduction to the degree they are not phased out by their single or MFJ taxable income. A sole proprietor’s QBI is their self-employed earned income – any self-employed health insurance deduction – any (pre-tax employee + employer contributions). An S-Corp 2% shareholder-employee’s QBI is their distributions. Generally a sole proprietor can claim a larger QBI deduction than an S-Corp 2% shareholder-employee.
There is no safe harbor on “reasonable compensation”. Rather it is based on the specific facts and circumstances with a comparative salary for a W-2 employee at another company with your knowledge skills and experience in your local job market. If there is a potential “safe harbor” now after the passage of section 199A , I would think it is when your compensation is >= twice your distributions. Congress and the IRS have penalized an S-Corp’s shareholder-employee, by limiting their QBI deduction to 50% of their W-2 wages. Note, this is not that difficult, because pre-tax retirement plan contributions reduce your distributions.June 5, 2019 at 5:12 pm MST #219510
Thank you for the detailed response. In general I agree with everything you wrote, and am pretty confident that a s-corp would save taxes.
I have no other income subject to FICA. In this example of 105k consulting fees received, 63 goes to wages, 15.75 to employer contributions to solo 401k, 4.8 is employer share of FICA, spouse is w-2 physician providing health insurance, leaving 21.5k as distributions. (I could probably go lower on wages, but am playing it safe with “reasonable”). This saves me about $6.4k in SE taxes.
My QBI deduction is only 4.2k, instead of 12k if I were a sole prop making max employer contributions. But even with a 10% state income tax and 24% federal income tax rate that only means I miss out on 2.7k of tax savings. That is more than offset by saving 6.4k of SE taxes. Plus I can make all 19k of employee contributions to solo 401k pre-tax without impacting QBI, whereas as a sole prop they would have reduced QBI by 3.8k. and those are valuable given I’m in a high income tax state.
I appreciate the sanity checking on whether the s-corp is worth it, by all means keep it coming as I don’t know what I’m unaware of (“unknown unknowns”). The filing fees and compliance aspect are non-trivial, but simpler than for most s-corps.
My big question though is if anyone knows whether it is permitted to assign the right to payment for work already completed to a s-corp formed after work is complete, but before payment is made.June 5, 2019 at 5:33 pm MST #219513
Where do you get $6,400 in reduced SE taxes?June 5, 2019 at 5:38 pm MST #219514
$6400 comes from the fact that no SE-taxes apply to S-corps. BUT, they do pay payroll taxes on wages. So 15.3% of 63k instead of 15.3% of 105k. I think that comes to 6,426 on $42,000 (105-63) of non-wage “net adjusted profit” (yes, I’m ignoring deduction for employer portion of SE-taxes and unemployment taxes).June 5, 2019 at 5:54 pm MST #219518
The 1/2 SE tax deduction is not negligible. About $2,500 at a marginal rate of 34%. Coupled with reduced QBI deduction, reduced solo 401k contribution, reduced SS credit, increased accounting costs, are you sure the delta is there at $105k income?
Also I’m surprised you’d make the 24% bracket with a physician spouse and $105k income yourself.June 5, 2019 at 7:17 pm MST #219533DavidGlennCPAParticipantStatus: AccountantPosts: 2Joined: 06/12/2019
As to everyone’s comments about whether an S-corporation is really warranted here, I’ve found it’s best to run a complete tax return both ways to truly find out whether an S-corporation saves you money or not. There are too many moving parts to do the math any other way.
As to the original question, the S-election can’t be effective any earlier than the underlying entity (LLC or Corporation) is formed. As long as you’ve formed the entity before you receive any payments you can report that income under the S-corporation. You would just make the S-election be effective on the first day the entity exists.
This assumes you’re using the cash method of accounting which recognizes income when it’s received and not when it’s earned.
For example, if you form the LLC that you’ll elect into an S-corporation on 6/1 but your first payment is received on 5/25 then that payment can’t be run through the S-corporation. It needs to go on Schedule C.
It’s also really important that the contract actually be made between your LLC/corporation and the company you’re working for rather than between you individually and the company you’re working for. There are court cases where this wasn’t done right and the IRS moved the income to a Schedule C.
If you’re making a late S-election please refer to Rev. Proc. 2013-30.
David Glenn, CPA | Glenn Advisory
https://www.taxcpafordoctors.com | (808) 321-5664June 12, 2019 at 11:31 am MST #221337