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Author: Mark J. Kohler

When to use an S-Corporation

An S-Corporation, is a common entity to save on taxes and most small business owners should be using them as their entity of choice.
Business owners around the country consistently ask me if an S-Corporation is a good match for their business. I can tell you that there is a lot at stake. So much so, that it is well worth your time to know the basic differences between an S-Corporation and LLC.
Surprisingly, there are advisors across the country that miss the mark. They might give truly damaging advice that costs small business owners thousands of dollars!
You are the captain of your own ship! You need to be able to determine if your professionals are advising you under well-recognized basic concepts.
Introduction to the S-Corporation
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LLC Taxed as an S-Corporation
An LLC ‘taxed as an S-Corp’ is the same thing as a standard S-Corporation set-up as an ‘Inc’. The IRS considers them to be the same.
When you convert to an S-Corporation (with a properly filed IRS Form 2553), your name won’t change with the State. You will still have the acronym ‘LLC’ at the end of your company name – and that’s OK!!
The main reason why business owners may start or begin their business with the LLC entity is so they can ‘convert’ or ‘elect’ to the S-Corporation when the time is right. This is an affordable process. Until the ‘election’ is made, the LLCs are taxed as a sole proprietorship or partnership.
But Remember, an LLC (Limited Liability Company) doesn’t save taxes whatsoever!! That is why we want to convert to the S-Corporation.
Benefits of an S-Corporation
The main benefit of an S-Corporation is to honestly and ethically save on Self-Employment Tax (SE Tax). SE tax, also referred to as FICA, consists of Medicare and Social Security taxes totaling a 15.3% hit on your bottom line. In a sole proprietorship or an LLC taxed as a sole proprietorship, SE tax is applied to every dollar of net self-employment income reported on Schedule C or earned on a K-1 from a partnership.
For small business owners, FICA taxes can dwarf even federal income taxes. People overlook this tax as mandatory and unavoidable. The S-Corporation is the solution.
In an S-Corporation, net income is split into a salary portion and a pass-through or net-income portion. They are pass-through entities (just like LLCs); so all the income it earns DOES NOT pay corporate tax. Along with any income is taxable to the individual owners in the year earned and is subject to ordinary income tax rates. However, in an S-Corporation, SE tax only applies to the salary, not on the net income. This means that for every thousand dollars you classify as pass-thru income, you save $150 in taxes!
Other benefits include:

asset protection,
the ability to contribute costs effectively to a Solo 401k,
building of corporate credit, 
AND a decreased chance of an audit.

That’s right! Estimates are that S-Corps are 15x less likely to receive an audit than a LLC/Sole proprietor, even though they save more in taxes!
In a perfect world, you could take all your income as dividends and avoid SE Tax completely, but the IRS requires S-Corps to pay owners a reasonable salary.
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When to Use an S-Corp
Here are the 5 Factors that might make you a likely candidate:
1. Do you have Income Subject to Self-Employment Tax?
The first question we ask clients is if they have income subject to SE tax. This is to determine whether or not they need an S-Corporation. Self-employment income is often referred to as ‘ordinary income’ derived from services or the sale of products. Ordinary income IS NOT income from a W-2. 

Passive income IS NOT subject to SE tax. Passive income is rental income, interest, dividends, capital gain, etc.
2. Are There Restrictions on me Operating as an S-Corporation in my Industry?
This question inevitably comes up in locales where licensing is required for your profession. Brokers, realtors, insurance agents, doctors, lawyers, and contractors all need to check with their local licensing boards to make sure they can operate inside an S-Corporation with their license.
The answer is usually yes, but some jurisdictions will require the license to be held by the S-Corporation. They will require the business owner to jump through hoops to make this work. In one recent case, a client told me it was going to cost him over $5,000 to switch his licenses over to the S-Corporation and could take months to complete.
If there are going to be significant hurdles to establishing your S-Corporation, you will want to assess the ultimate tax savings and whether the benefit of it outweighs the cost before making that decision.
3. How much Income do I need Before an S-Corporation Makes Sense?
This is a critical question because a business owner doesn’t need or want to incur the cost of an S-Corporation unless the tax savings exceed the cost. We have generally advised our clients that the break-even point is approximately $40k in net income.
Otherwise stated, if your business is making net ordinary income subject to SE tax of $40k or more then you are a candidate for an S-Corporation. The reason why we feel this is the ‘break-even’ point is because of the salary/net-income allocation. We are careful and cautious to make sure and tailor payroll allocations to each business owner and their situation. Oftentimes there can be $2,000-$3,000 in savings at this threshold.
Again, meet with an advisor that truly understands this strategy and is willing to be cautiously aggressive. To meet with a real tax attorney about whether an S-Corporation is right for you, visit KKOS Lawyers.
4. How will this Affect my 199-A Deduction?
The 199-A deduction is a product of the Tax Cuts and Jobs Act and gives small businesses an automatic 20% deduction on all pass-through income. The deduction can be subject to a phase-out calculation for professional service business owners with AGI (adjusted gross income) over $157,500 for single filers and $315,000 for joint filers.
There is also another calculation that kicks in for non-professionals when they hit similar income levels. Bottom line, this is a wonderful deduction that is not inhibited by the S-Corporation. It is enhanced with the strategy of the S-Corporation. A qualified tax advisor will help its business owner clients to find a balance between salary and net income to minimize SE tax and maximize the 199-A deduction. It’s a huge opportunity for planning!
5. How much will an S-Corporation cost me?
First, you have setup costs. This can range from $200 to $1,000 depending on the amount of consultation, support, and documentation provided by the law firm performing the service. We urge you to be cautious in this process. It IS NOT simply a ‘filing of articles’.
There are multiple documents to include. Consulting and support are critical for a business owner new to the S-Corporation and need to understand the maintenance procedures. We charge either $400 or $800, plus the filing fee, for an S-Corporation in any State in the Country.
Next, you have the ongoing maintenance and the quarterly and annual tax filings. With it you will be paying yourself a salary. Even if you don’t have other employees you will have to do payroll and file quarterly payroll reports with the IRS. It also must file its own year-end tax return and issue you a W-2. These annual costs could range from $1,500-$2,000 depending on your situation.
This is why the ‘savings’ for an S-Corporation owner needs to be more than $2,000 before it makes ‘financial’ sense in the first place. Although the other reasons for asset protection, corporate credit, and audit risk reduction still may all make sense, it’s important to understand the financial situation before pulling the trigger.
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Conclusion
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Get a Consultation or 2nd Opinion
I am convinced after over 20 years of experience both personally and in our office helping and supporting thousands of business owners, the S-Corporation is ultimately the best entity for an operational business owner in the long run.
Don’t underestimate the power of the S-Corporation. You should make sure to get a second opinion if anyone says it isn’t the best match. Ironically, more people are avoiding the S-Corporation and being talked out of it by an uneducated advisor, rather than prematurely setting up an S-Corporation.
The attorneys in our office are all capable of helping you with this decision based on these factors and more. All things considered, the cost of a consultation is much less than the cost of making a mistake and filing for the wrong entity!

The Real Estate Professional Tax Strategy

Those that follow my lectures and writings know that I recommend Americans consider buying one rental property a year. It is apart of a great real estate tax strategy. You could have full or partial ownership when investing with a partner. It could be a single family home, commercial property, VRBO short-term rental or even a group of mobile homes. 
Why do I say this? Five primary reasons.

Steady appreciation over the long-term
Tax Deferred growth and capital gain treatment
Tax free cash flow
Mortgage reduction through renter’s payments
Tax write-offs through business expenses and depreciation

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Real Estate Tax Strategy
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Now I realize rental property is not a perfect fit for everyone. There are a lot of variables…your financial strength, credit worthiness, your temperament and time you have to manage property. IT also depends on the season of your life.
I encourage all of you to ‘at least’ consider buying one rental this year (in or outside of your retirement account) and determine if it is a good fit for you.
Once an investor starts buying rental real estate, one of the top strategies we recommend to our clients is to consider the benefits of qualifying as a Real Estate Professional. As many real estate investors quickly discover, rental real estate has the amazing power to potentially provide tax losses/deductions with tax free cash flow, on top of building
However, although buying real estate is something every investor should consider, being a “real estate professional” ISN’T for everyone. Don’t feel like this should be the first priority in tax planning when it comes to real estate. This classification only helps WHEN you have multiple rental properties. Along with when you make more than $150,000 a year in Adjusted Gross Income.
Classifying Real Estate Investors
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There are three categories the IRS uses to classify real estate investors, each having different pros and cons.

The first classification is that of a “Passive Investor”. This is the least beneficial category and only allows a taxpayer the ability to deduct passive losses against passive gains.
The second classification is that of an “Active Investor”. This designation allows a taxpayer to deduct an additional $25,000 of losses against ordinary income, however, this deduction phases out completely at the Adjusted Gross Income (AGI) level of $150,000 for a married couple filing jointly and $100,000 for a single individual. Anyone can qualify and to do so must simply be involved in the decision making for the real estate investment, and doesn’t even require the taxpayer to make a special election on their tax return.

Third, the “Real Estate Professional” classification allows taxpayers to deduct 100% of all real estate losses against ordinary income…IF they qualify and WANT to qualify.

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How to Qualify as a Real Estate Professional
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To meet this threshold, a taxpayer, or their spouse, must meet a three-part test. First, the taxpayer must spend the majority of his or her time in real property businesses.
Second, the taxpayer must spend 750 hours or more in the industry of real estate or in the ‘real property business’. The biggest question we are often asked is what occupations qualify as real property businesses. The IRS does not statutorily list which jobs qualify. If you are working as an entrepreneur in the real estate industry, if you have a license or not, we want to talk about it.
Finally, the third test is that the taxpayer must ‘materially participate’ in the management of the properties. However, the beauty is that you can qualify for material participation under another 7 different tests, which in practice are quite easy to qualify for.
Again, as a cautionary note, it is important to realize that qualifying as a Real Estate Professional is not a ‘fit’ for every taxpayer. It is surprising how many taxpayers get fixated on being a Real Estate Professional as their primary tax-planning goal, while others avoid it like the plague. Yet, there are still others that don’t even know what the fuss is all about.
Let’s break it down and see where the truth may lead you in your personal planning. First, let’s talk about the ‘bad news’ if you will, and why some folks feel that being a “Dealer” or “Real Estate Professional”(essentially the same thing) is the death nail on a tax return.
The Problem with being a Real Estate Professional
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There are 2 major issues with being a “Dealer” and can provide legitimate concern for the taxpayer.

A 1031 exchange is a powerful strategy and only getting more popular again as real estate values rebound. A 1031 exchange allows you to sell property(ies) and exchange them for equal or greater value with another property(ies). However, if you are a Dealer the IRS will most certainly hold you to higher standards in order to qualify for a 1031 exchange.

Next, if you are a Professional than the IRS considers your short-term gains and income in all of your real estate activities as ‘ordinary income’. As such, this income will be subject to self-employment tax. While easily mitigated with an S-Corporation, it’s something a Dealer needs to reckon with and the new real estate investor isn’t blindsided by its wrath.

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The Benefits of being Classified as a Real Estate Professional
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There is essentially one major benefit to being a Dealer, a tax benefit, and that’s the reason for all of the hype.
As a real estate professional, a taxpayer is allowed to deduct one hundred percent (100%) of their rental real estate losses against any other type of income. As my clients have learned through my book, articles, and presentations, rental real estate can cash flow wonderfully. It still has the ability to create passive loss write-offs due to depreciation and mortgage interest expenses.
Right now in my life, I’m not a real estate professional, and that’s ok. I am limited on my tax return to a maximum of $25,000 in rental real estate losses until my adjusted gross income reaches $150k. At that point, the losses aren’t “lost” they are just captured. Then they will carry forward until I sell any one of my properties.
Bottom line, I encourage all taxpayers to consider and be aware of the strategy. If you don’t have rental property, don’t stress. If you do have rentals, then the strategy can become even more important. You want to make sure you are classifying yourself properly. Make sure you consult with your personal tax consultant to determine if this should be part of your tax plan this year or in years to come.
No matter what, keep buying and holding real estate in your portfolio; real estate professional or not. If you are looking for help on how to implememt this strategy, schedule a meeting with one my attorneys at KKOS Lawyers and they can help you!

Should I put My Spouse on Payroll?

Whether or not to put your spouse on the payroll for tax planning purposes is a very strategic question and something we often analyze for clients. In fact, many clients rush to put their spouse on payroll, but for the wrong reasons. It could actually be quite a costly mistake. 

Two reasons why NOT to put your Spouse on a Payroll

First, here are two big reasons NOT to put your spouse on payroll. These are actually common mistakes or misconceptions on why one may put cut the non-working spouse a check. 

Misconception #1- So the non-working spouse can contribute to an IRA – Wrong. A non-working spouse does not have to have a ‘paycheck’ in order to contribute to a traditional or Roth IRA. The non-working spouse can create what’s called a Spousal IRA. There are really only two requirements. One, the working spouse has eligible compensation that’s at least as much as the total contribution to both IRAs. Two, they file a joint income tax return. Bottom line, don’t cut a paycheck to simply fund an IRA or Roth IRA.

Misconception #2- To get a Social Security benefit for the non-working spouse – Wrong. On the face of it, this would seem logical, right?  However, a “non-working spouse” of a “working spouse” already qualifies for spousal benefits. The benefits are limited to 50% of the working spouse’s primary insurance amount, but to get more than that amount a ‘non-working spouse’ may need to pay into the system for years. Thus, going on payroll may not get the ‘non-working spouse’ more than they were already going to get! Speak with a financial advisor that understands Social Security planning to run the “numbers” before cutting another payroll check. I cover this topic in-depth and dedicate an entire chapter to this strategy in my book with Randy Luebke: “The Business Owner’s Guide to Financial Freedom- What Wall Street Isn’t Telling You”.

A Spouse is Always Working for the Business

As a preliminary matter, I always believe it’s a misconception that the spouse is considered ‘non-working’. A spouse is always an integral part of a business…no doubt about it. The spouse should also be serving on the Board of Advisors or Directors for the company.

A spouse would presumably be constantly involved in the operations of the company. Thus, a salary would always be justified and appropriate IF it makes sense for tax planning.

Good Reason #1 – Maximize the Spouse’s 401k contribution

If a business owner and their spouse want to put away some big money for retirement, they may qualify for the Solo 401k. If so, BOTH spouses need to be on payroll AND for the proper amount to max out the 401k match. There’s even the option for an incredible ‘next level’ strategy referred to as the “Mega Back-Door Roth”.

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In 2024 the primary business owner and their spouse can EACH contribute up to $22,500 (or $30,000 if 50 or older) into a 401k. The business is allowed to take a tax deduction for the W-2. Neither spouse has to claim the contribution as income on their 1040 (if a traditional contribution and not a Roth). 

Yes…there is some FICA or payroll tax due on the W-2 amount for each spouse in order to ‘fund’ the 401k, but the ultimate tax benefit is significant due to the ‘time value of money’ and building a tax-deferred retirement account. Typically, it’s customary to  ‘gross-up’ the payroll amount on the spouse to cover the FICA taxes. Then ‘zero out’ the rest with the contribution to the 401k.

401k Contribution Examples

This is an incredible opportunity for the spouse of a business owner. The spouse can create and fund a 401k with a net taxable income of zero! But it gets better!! In addition to the deferral the spouse could make from their paycheck, the company can also do a match on the total payroll amount to the spouse. This would further be a deduction for the company and add to the spouse’s 401k balance.

EXAMPLE #1: If your spouse is under age 50, the payroll amount would be approximately $22,198, with a net pay of $20,500. Then the spouse would elect to ‘defer’ or contribute $20,500 to the 401k, and the W-2 nets out at zero (assuming a Traditional contribution and not Roth). The company would ALSO be able to contribute 25% of the spouse’s payroll into their account of $5,549. The company would have a total tax deduction of $27,748, and the spouse would end up with $26,049 in their 401k!

EXAMPLE #2: If your spouse is age 50 or older, the payroll would be approximately $29,237, with a net pay of $27,000. Then the spouse would elect to ‘defer’ or contribute $27,000 to the 401k, and the W-2 nets out at zero (assuming a Traditional contribution and not Roth). The company would ALSO be able to contribute 25% of the spouse’s payroll into their account of $7,309. The company would have a total tax deduction of $36,546, and the spouse would end up with $34,309 in their 401k!

In fact, if a business owner and spouse can afford to pay a little more in taxes, they can get even more creative. They can fund a ROTH 401k and create tax-free accounts, rather than just deferring taxes until the future. 

Good Reason #2 – Potentially Write off More Medical Expenses

Essentially, if your family has a lot of medical costs, put your spouse on the payroll. It may allow you to utilize the Health Reimbursement Arrangement (HRA).  However, keep in mind that you would have to utilize a sister management company (typically a Sole-Proprietorship). 

It’s important to note that the HRA strategy is impossible for a business owner to use with their S-Corporation without the use of the Sole-Prop. The reason being is the “greater than 2% shareholder rules” that prevent a business owner (or their spouse) from deducting certain fringe benefits for themselves (this includes the HRA).

However, the ‘backdoor strategy’, is to create a ‘support’ or ‘management’ company that would hire the spouse for services provided to the main company, and under this employment relationship provide for an HRA. 

On the face of it, the HRA may sound complicated or expensive, but it is rather quite simple and affordable. It is ‘self-administered’ without the need for an insurance company or bank’s involvement. See “How an HRA can Save you Thousands when facing extra Health Care Costs”.

The beauty of the HRA plan being provided through an employment arrangement is that the payroll may be minimal, OR it can be used in conjunction with a larger payroll amount and a 401k contribution. The cost is under $500 at our law firm KKOS Lawyers, or accounting firm K&E CPAs.

DRAWS…The Easy Solution

 Let’s look at this logically:

If you have a spouse, then you’re married.

If you’re married, there’s a 99% chance you’re filing a joint 1040.

If you’re filing a joint 1040, then the income from the business is taxed to both of you.

If the income is taxed to both of you, then ‘Distributions’ or ‘Draws’ to your spouse are treated as if they are distributions to you.

Give your spouse a freaking Distribution/Draw if they need money

Here is a visual representation of multiple options:

For illustration purposes only.

In Summary, the 401k contribution and the HRA are the only reasons I think business owners should consider having both a ‘non-working’ spouse on the payroll. Make sure to bring this up with your tax and financial advisor to apply these strategies to your particular situation. Schedule a consultation with one of our tax lawyers at KKOS Lawyers and within an hour they can explain and design the right ‘Comp’ structure for your spouse!

The Eviction Moratorium – What Landlords Should Know

This week in the Main Street Business Podcast Mat and Mark discuss a different perspective on the extension of the eviction ban. They cover some surprising statistics about how many landlords are really small business owners versus large corperations. This is not an episode you want to miss.In addition, they give some invaluable tips to landlords to help them keep up with their mortgages and potentially even avoid foreclosure. To read Mark Kohlers article on this topic visit: https://markjkohler.com/eviction-ban-expires-just-in-time-to-save-landlords/To search for prior episodes or learn more visit: https://podcast.mainstreetbusiness.com/

Making the Most of the HSA & HRA – Game-Changing Health Care Strategies

Making the Most of the HSA & HRA – Game-Changing Health Care Strategies for small business owners and entrepreneurs. Mark and Mat cover so many important items that every business owner should know. Don't miss this episode! To learn more or search for prior episodes visit: https://podcast.mainstreetbusiness.com/

Writing a Book – A Good Business Move?

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Mark and Mat cover the three main concepts that billionaires Jeff Bezos, Donald Trump, and Peter Theil use to save taxes and grow their wealth. They emphasize that although these concepts are used by billionaires, they are just as applicable AND accessible to the everyday American. Everyone hoping to build wealth NEEDS to understand these concepts and how they can be applied in their life and business. Learn more and listen to prior episodes at https://podcast.mainstreetbusiness.com/