Transcript:

[00:00:00] Voiceover: Welcome to the Life Unlimited Podcast with Larry Heller. You deserve complete financial advice so you can confidently live your life your way for life. Now let’s get into this week’s podcast episode. 

[00:00:00] Matt Halloran: Hello and welcome to another Life Unlimited podcast with your host, Larry Heller. Today we’re gonna be navigating as Corporation tax rules with William Huether. Now he joined Sheehan & Company C-P-A-P-C in 2013 and is a certified public accountant in New York State. As a partner, he provides assurance, accounting, and tax services across multiple industries.

[00:00:20] Matt Halloran: While playing a key leadership role, including chairing the recruiting committee and mentoring staff, William has received several honors, including the Long Island Business News, top 40, under 40. That’s really cool, by the way. Uh, he’s also actively involved in the N-Y-S-S-C-P-A, serving both the Suffolk Chapter and the statewide board of directors.

[00:00:41] Matt Halloran: Larry, take it away. 

[00:00:42] Larry Heller: Thanks, Matt. thanks Bill for joining us Today we’re gonna talk about kind of forming corporations and s corporations, some of the pros and the cons. A lot of good information out there if you’re already a corporation or you’re thinking about starting a corporation. So, uh, bill, let, let’s kind of, you know, get right to the start.

[00:01:00] Larry Heller: So when you’re forming a corporation, I guess. People just think there’s even one corporation. But let’s talk about the differences in some of the corporations and especially we’re gonna be talking about scorp. So what is an S corp? How do you become an S Corp? 

[00:01:16] William Huether: Sure. So a lot of people, when they form a new entity, I.

[00:01:21] William Huether: And by the way, it’s good to be with you guys today, but when someone forms a new entity and they form a corporation, most people will say, I just want to have a corporation. I’m gonna form one. [00:01:30] They’ll go online and sometimes they’ll just do it by themselves and they’ll try to do a legal zoom or something like that, and they’ll form a corporation, and then they’ll think that automatically they’re an S corporation.

[00:01:40] William Huether: When you form an actual corporation, you become a C corporation by default, and what that means is a C corporation is a separate. Entity by itself that gets taxed as that separate entity by itself, meaning that any income that that entity makes or brings in. Is subject to an entity tax. Right now at the federal level, there’s a flat entity, uh, C corp tax at 21%.

[00:02:08] William Huether: Obviously we’ve been hearing discussions over the next couple weeks about how that may change over the next couple of years. Um, but the downfall about it is the entity will pay tax on that. So it’ll pay the federal tax and the New York State or whatever state it’s based in it’s tax. Um, but then you as an owner.

[00:02:26] William Huether: Of that C corporation will also then pay tax, because if you take money out of a C corporation, that becomes a dividend and then you get taxed as that dividend coming to you now from a lot of businesses on small businesses and whatnot, people like to become s-Corps for a variety of different reasons.

[00:02:46] William Huether: And an S-Corp is really an election. It’s an election of how you want to be taxed and structured from a business standpoint. So an S corporation is a separate entity, however, it is a flow through entity. [00:03:00] So a flow through entity like an S Corp means that you don’t pay a specific entity tax at the entity level.

[00:03:08] William Huether: So if you have your own company where it’s, you know, Bill Huether and company right? And that’s a C corporation that would pay tax on a C corporation. But if you become an S corp, then you don’t pay tax as the entity, but that income will flow through to you, um, to form an S corporation or get the election for it.

[00:03:30] William Huether: There is an election form on the federal side. Which is form 25 53, you’ll file that. And that’s usually due by, if you’re calendar year, March 15th of the first year, you’re electing. Some states will follow the federal, but New York and there’s a bunch of other ones that you’d have to file separate, um, election requests to be become an S-Corp in those states.

[00:03:51] William Huether: But, you know, every state has different laws, so we’ll have to look at that to make sure that every state. 

[00:03:58] Larry Heller: So you unpacked a lot of different things there. So if you’re file, if you wanna become an s-corp, you gotta file separately and I’ll make an s-Corp election, both federal and possibly state. And really, I, I guess what you’re saying is the, the, the main benefit of an S corporation versus a C corporation is saving on taxes.

[00:04:19] William Huether: Well, there’s, there’s a, a pub, a bunch of different benefits and definitely from a tax perspective, and again, you know, c corporations may be a good option for somebody depending on what your [00:04:30] goals are down the line. You know, do you wanna become an ESOP eventually? Do you wanna eventually sell the business and you’re anticipating large capital gains?

[00:04:38] William Huether: There might be some tax impacts, but from an s-Corp standpoint, one, as we kind of discussed already, um, you avoid the double taxation. So as a small business owner, you’re not paying taxes. The entity level, and then when you pull money out, um, the second benefit of an s-corp that you know is, is something that people really enjoy about them or like about them, is as an owner in an s-corp or shareholder in an S corporation, you receive a form K one, which essentially will lay out all of the income, your share of the income that will flow through to you, that you’ll pick up on your.

[00:05:13] William Huether: Personal tax return. Now as an S-Corp, that income that flows through to you is not subject to the self-employment taxes, which are the FICA and the Medicare and all of that stuff. You know, if you were a partnership, all of that would be subject to that, which is, which is substantial. I mean, you’re looking at, on the employee side alone, 7.65% fica, and then you have the Medicare 1.45.

[00:05:39] William Huether: And then you’d have to cover the employee piece as well. So you are looking at a 15% tax on that. So those are really the main benefits. And also, um, you know, it’s, it’s easy to kind of navigate and it’s certainly, um. Certainly an option that most people like, but the tax piece of it is something that’s appealing.[00:06:00] 

[00:06:00] Larry Heller: So I can set up an S corporation and don’t have to take any salary and play employment taxes and make a million dollars and just take that as a K one distribution and have no problems. 

[00:06:10] William Huether: That’s what most people like to think. Uh, but no, that’s the background of the S corp. That’s the downfall of it, where you’re not gonna not get out of not paying those taxes.

[00:06:23] William Huether: So as an owner employee in an S corporation, I. You’re required to take a reasonable salary, um, which obviously would be a deduction from the business, but you’re still picking that up, obviously through a W2. Now, the biggest question you always get is, well, what is a reasonable salary? You know, can I take, if I have a profit of, you know, a million dollars, can I take $10,000?

[00:06:46] William Huether: And is that good? Just ’cause I’m putting someone on W2. Um, the answer is the IRS really doesn’t define what reasonable salary is, but I can say it’s probably very easy to spot what is not reasonable. Um, definitely the way to look at it. Is, you know, what, in your role of what you are doing for the business, what would someone in the relative field in your area be being compensated for?

[00:07:12] William Huether: Because if the IRS is gonna come in and look at you and kind of look at the business and say, okay, is this reasonable? You know, if you’re not kind of in a comparatively similar situation to others, you know, it’ll be easy for them to say, well, we’re gonna deem that it’s not reasonable, and then they may [00:07:30] have.

[00:07:30] William Huether: Some adjustments for 

[00:07:31] Larry Heller: you, but go ahead. And then there are other factors that come into plan. Put my, you know, my thinking, planning hat up. So one I is if you don’t ha, the lower the salary, if you’re below the maximum that you qualify for social security, that you’re not putting away the most in social security.

[00:07:49] Larry Heller: Correct. So absolutely that would be, you know, so I, I Sometimes I hear people in corporations while they. Their salary, their reasonable salary is the max amount for social security because then they’ve hit the limit and there’s no reason to be any higher. Do you see that happening a lot? 

[00:08:08] William Huether: Yeah, no, you certainly see that a lot and that’s a very, um, traditional way of people trying to come up with that.

[00:08:14] William Huether: But it really, again, depends on the industry, depends what you’re doing. You know, the other piece of it though, that you have to look at too, is if you really are. The sole employee of the company and the owner, and you don’t have any employees. And you’re the one generating all of the business. You are the one doing all of the work and providing the services.

[00:08:38] William Huether: The IRS can eventually come in and say, Hey, well listen, you know, you really are acting as an employee. So really almost all of the compensation that you are bringing in should be subject to, you know, compensation on a W2. So it’s, it’s looking at all of those different factors and there’s not just a one answer that fits all industries.

[00:08:57] Larry Heller: Right. And, and from my factors sometimes [00:09:00] too. And we get. Called in to look at a possible retirement plan while looking at the salaries, because the salaries determine what type of retirement plan you can put in place and how much you can put a put away, and sometimes a higher salary lets you put away more money in a retirement plan.

[00:09:19] Larry Heller: So I guess that factors in, in and of itself, um, as well. 

[00:09:25] William Huether: Yeah. And ultimately I, you see a lot of people that when they’re setting up and forming businesses, they initially say, well, I just want the best thing that’s gonna save me on taxes. And oh, if I’m not paying my self-employment taxes and I’m avoid double taxation, that’s great.

[00:09:39] William Huether: But then again, like to your point, you have to look at it as a holistic approach. You have to look at it all right, what is one? Is the entity something that would benefit me in the long term? Does it fit my business need? Does it fit my goals going forward? And then two. From a personal financial standpoint, you know, from the retirement side, okay, I want to pay myself this, but can I get a better benefit or could I put more money away based on how I’m structuring that compensation?

[00:10:07] William Huether: So there’s a lot of factors, but uh, a lot of people do come in, they go, oh, I don’t have to pay those taxes. Uh, that’s great, but there’s a lot involved. And you do ultimately pay them just in some, some sort of fashion, however. I wanna talk a little bit 

[00:10:20] Larry Heller: more about S Corporations, but I know that’s what the topic is today, but lemme just touch upon, ’cause there are other entities that you could do such as, [00:10:30] like you said, a partnership or, um, what’s been big, you know, I guess the last few years is an L-L-L-L-C.

[00:10:37] Larry Heller: Yep. So why don’t you just kind of mention that and also kind of say what the pros and the cons are of some of those. 

[00:10:44] William Huether: Sure. So as a regular LLC limited liability company, from a taxation standpoint, if you start an LLC and you are a single owner of that LLC, that’s really the most basic form of setting up an entity.

[00:11:00] William Huether: Um, and I really say that because with that, there’s no separate entity filing. It’s, it’s referred to as a disregarded entity for. The tax purposes so you don’t have to file a separate tax return or anything to that effect. You would be filing that income and expenses on your personal tax return on Schedule E or Schedule C for business.

[00:11:21] William Huether: But if it’s rental Schedule E, um, so there’s no separate tax there, um, it’s a little bit easier to set up ’cause you get the. You do your formation documents and whatnot, you’re the only owner, so you don’t have any partnership issues to deal with. Um, but the problem is if you have just an LLC, um, from a taxation standpoint, any of the income that you make through that, if you have obviously profit in that, um, it’s subject to the self-employment taxes, which as an owner in an LLC, you’re paying both the employee.

[00:11:56] William Huether: The employer portion of it. Now you’ll on your income [00:12:00] tax return, ultimately you’ll get a deduction for half for the employee piece of it. But you’re still paying those fees, uh, that tax, which is, you know, increasing your tax liability partnership. Oh, go ahead. No, go ahead. Oh, okay. So a partnership ultimately is an LLC, essentially, and there’s a bunch of different partnerships.

[00:12:20] William Huether: It’s limited partnerships, limited liability companies. There’s, there’s a whole bunch of different ones, but in general, a partnership is an LLC that has more than one owner or partner. Now, once you bring on another partner, now that’s requiring you to file a separate. Tax return for that entity is a partnership income tax return.

[00:12:40] William Huether: Um, so now the cost of, you know, the compliance is a little bit more, you certainly wanna make sure that you get those legal documents in order with the partnership agreements and all that good stuff. So that’s a real high level overview and you can go down lots of rabbit holes with them. But that’s a general overview.

[00:12:57] William Huether: And again, from a taxation standpoint. Partnership income is subject to the self-employment tax. So if you’re an accident partner. 

[00:13:04] Larry Heller: So, uh, so speaking of taxes, so a few years ago, um, they, the, the, uh, government decided to pass a law to cap, um, the deductions for estate taxes. So. Uh, one of the ways I guess around that, that’s been formed is what’s called in New York State has been called a pass through entity.

[00:13:28] Larry Heller: So why don’t you kind of [00:13:30] talk what, what, what about this pass through entity? Who’s entitled to it? Which corporation’s entitled to it, and what does it really do and how does it really benefit you? Sure. 

[00:13:38] William Huether: So yeah, so back when the Tax Cuts and Jobs Act were passed, uh, one of the biggest changes was the cap on the state and local tax deduction on the Schedule A of people’s personal 10 40 income tax returns, 

[00:13:51] Larry Heller: which is 10 $10,000, correct.

[00:13:52] William Huether: Correct. It was capped to $10,000. Um, and that, that hurt a lot of people because obviously if you’re a business owner, you’re, you’re paying a tremendous amount and you’re doing well. You’re paying a lot in state income taxes and everything else. Um, so what a lot of states did, and including New York now, which we’ll talk about is they passed a passed through entity tax election.

[00:14:15] William Huether: So, uh, what that is eligible for are businesses that are passed through entities. So obviously you mentioned S Corps, but partnerships as well. So anything, obviously that’s not a C corporation that the income flows through to the owners. Um, so how does that work? So the way it works essentially is. As we spoke about before, on an s-corp, you’re not taxed at the entity level.

[00:14:41] William Huether: So if you were to make an election, which every year for the New York State passed their entity tax, it’s an actual election you have to make each year. So once you make it, you don’t, it’s not like you have to do it every year. You have to elect in every year. But essentially what it’s doing is making you have the election to say, okay, from a New York [00:15:00] State tax perspective, I’m gonna opt to pay the taxes at an entity level.

[00:15:05] William Huether: So I’m gonna have my S corporation pay taxes to New York State. On a quarterly basis. But what that does is that allows you to take a deduction of those taxes that the company pays through your for your income, which will then ultimately reduce the income that flows through to you. So ultimately, you’re getting a deduction.

[00:15:28] William Huether: On your federal income tax return as well. From the state perspective, it’s nice because you obviously, you get that reduction, so your taxable liability or taxable income will be reduced. You have to add it back on the New York state as income, because obviously they’re not gonna get the best of both worlds.

[00:15:47] William Huether: But what it allows you to do is then it allows you to take an actual credit on the New York State Income tax return for the amount that you got the credit for. So. It’s almost like shifting estimated taxes from you personally to the business, but it allows you to take the deduction and exceed the $10,000 cap.

[00:16:04] Larry Heller: Hmm. And that’s not for every state, that’s just New York that’s doing Some states, not most, 

[00:16:09] William Huether: most states at this point have some sort of pastor entity tax. Every state might be a little bit different. But New York State was certainly over the last couple years, one of the newer ones that came on board and obviously working with a lot of people in New York was, uh, certainly, uh, an area that people.

[00:16:24] William Huether: Take advantage of. And if you’re a profitable business, it makes sense. 

[00:16:28] Larry Heller: Hmm. So do you think [00:16:30] there’s any chance that they repeal the cap on the state taxes going forward? Because most states are found to work around. 

[00:16:37] William Huether: I. It is hard to say. I mean, it’s really kind of hard to say, you know, what the next year or two look like.

[00:16:42] William Huether: I know it’s on the table. Um, there’s a possibility they do something like that, which, you know, I can see it happening, but then I can see the other side. Hmm. The way our, our, uh, politics are working these days, it’s hard to. It’s hard to make that prediction, 

[00:16:59] Larry Heller: but Right. 

[00:17:00] William Huether: And this is a workaround and a lot of companies, most of my clients are taking it.

[00:17:04] William Huether: The only ones that typically are not going for it is if you’re really not generating enough profit or income in a certain year that you’d really get a benefit for it, because obviously. With the election, you have to now file, you’ll have to do quarterly estimates, but then you have to file a separate pass through entity tax return for the state.

[00:17:24] William Huether: So if the cost of doing that doesn’t exceed your benefit, then it doesn’t make sense to do that, 

[00:17:29] Larry Heller: right? So that’s an important fact that you have to file another tax return for the pass through, through, through the pass, through entity. 

[00:17:35] William Huether: Correct. And if you’re, say you’re based in New York State and you have partners that are not New York State residents, uh, there’s definitely a calculation where the New York non-residents, uh.

[00:17:47] William Huether: You have to calculate the allocation between them because non-residents won’t get the same as actual New York State residents. So it can, if you have a lot of outside of the state resident partners, it could become a little bit more complicated on how you [00:18:00] allocate that income to get the credits.

[00:18:01] Larry Heller: Interesting. So speaking of outta state, does all jurisdictions recognize the scorp for tax purposes? They do not. And uh, 

[00:18:10] William Huether: you know, most, most states will. But you have a lot of even local areas that won’t, and we see all the time, and I see all the time you have clients obviously in New York state that are operating in the city or they’re based in New York City.

[00:18:25] William Huether: Um, and that’s a perfect example. So New York State will accept the S Corp election, which is fine. New York State, you actually have to file a separate form, CT six to get that election approved. Um. But New York City, on the other hand, doesn’t accept s-Corp elections. So if you have an entity that is an s-Corp for the federal purposes, um, an s-Corp for New York State, you still have to pay an entity level tax at the New York City level.

[00:18:52] William Huether: So, you know, we see clients all the time where you’re doing a lot of business in New York City and that income gets allocated to the city. You may have a lot of employees in the city. So that income is getting taxed at that level. So you might not be paying federal or New York state income tax, um, on that return, but you’ll have a city balance due.

[00:19:12] William Huether: Mm. Now have a lot of clients in DC the same thing. DC won’t recognize, uh, escort elections. Mm. 

[00:19:18] Larry Heller: So, so kind of in wrapping up, ’cause we covered a lot of different areas between s-Corp and c-Corp, and I guess someone just starting out, they may not even realize there’s an LLCs and partnerships, you know, how do you help [00:19:30] guide somebody to decide by not only looking today, but looking forward into the future, which entity to, to set up.

[00:19:38] William Huether: Yeah, so, you know, certainly what I like to do when I meet with people is one, you know, have a conversation and kind of get all the facts, you know, understanding. All right. What is your goal with the business? Where do you see yourself with this business in a couple years? Is your intent to sell the business?

[00:19:55] William Huether: Do you want to, are you looking to grow something then sell it? Are you looking to really just grow this and develop a legacy for your family, or are you looking for all of these different. Things and everyone’s different. And a lot of people, they won’t know that right now, but at least we can look at different options.

[00:20:11] William Huether: And what we’ll do is we can run scenarios and say, okay, well if you wanted to go this route and you wanted to say, listen, I want to sell my business, uh, or I want to get investors down the road, maybe a C corp might be beneficial, but let’s look and run some numbers. You know? And it’s always beneficial.

[00:20:29] Larry Heller: Go ahead. If they, if they have a corporation already set up, they, they. May want to kind of talk to you about does it make sense to change the corporation based upon what’s going on? Uh, yeah. Do you, do you come across that at all? 

[00:20:42] William Huether: You 

[00:20:42] Larry Heller: do a lot. 

[00:20:43] William Huether: You certainly, I see it all the time. Um, and again, it’s a lot of the times where people will set up these corporations not realizing that it’s not an s-corp.

[00:20:52] William Huether: We’re not realizing that what the tax implication is of a corporation, because, you know, if you’re not that [00:21:00] savvy in the legal. Realm, or even from a taxation standpoint, people just think, oh, it’s a corporation. I’m gonna open a new business. I’m gonna form a corporation not knowing the differences of the different corporations, the different, uh, organizational types.

[00:21:14] William Huether: So, um, see that a lot. And then we see it a lot too, where. You know, I have, I’m working with clients now where they were formed as a C corporation many years ago for a certain reason. Um, again, maybe they wanted to take on investors at a certain point, or they saw themselves building it in a different direction.

[00:21:31] William Huether: And now, after being in business 10 years or so, they’re like, well, you know what? I don’t know if. That is where I really want to go at this point. So maybe now I’ll decide to do an S election, which can do that. But then there’s other tax implications there where you have to analyze all the profit that was in the C corp and that kind of stuff.

[00:21:50] William Huether: So we go through all of that. We’ll look at all the factors and situations and see what comes to the best result, um, for the client and the business. 

[00:21:58] Larry Heller: Hmm. So great, great information. So, you know, for those of you out out there that you’ve just been kind of running the same way with the same corporation, you might even not realize that it, it may, may make sense to have a professional kind of look at the corporation and kind of see the future and see maybe way you may want to change.

[00:22:16] Larry Heller: ’cause it could mean, uh, literally thousands, maybe millions of dollars in, in tax savings. So any final word, bill. 

[00:22:24] William Huether: No, I think it’s really just for anyone out there. It’s just looking at those questions and [00:22:30] really asking the questions. Don’t feel stupid asking the questions and reach out to those that can give you some advice and guidance because there’s not one size fits all answer I.

[00:22:39] William Huether: Um, a C Corp might be great for somebody, an escort might be great for somebody. An LLC might be great for somebody, and it really depends on the needs. So certainly don’t just go out there and form something just because you want to get it going. You want to have some thought behind it because obviously there’s ramifications and you know, people like myself and like yourself are there to kind of help, you know, guide those discussions and work together to see how we can make a good decision for a client and their future.

[00:23:08] Larry Heller: Awesome. Great information. I know we, we covered a lot of things. Maybe some of it’s a little bit more technical, but if, if somebody wants to kind of at least reach out to you and kind of talk more about this, where’s, how, how do they can get ahold of you, bill? 

[00:23:20] William Huether: Well, they can always reach out to me at my email, um, which is w.

[00:23:26] William Huether: At shehan cpa.com you can always gimme a call 6 3 1 6 6 5 7 0 4 0 or just check out the website, shehan cpa.com and all my contact information is there. But always happy to have just initial conversations and talk about the, you know, if you have initial questions or anything like that, happy to just, you know, advise and kind of have an initial dialogue with anybody and just help them out.

[00:23:50] Larry Heller: Great. Thanks so much for joining us today. Be No 

[00:23:53] William Huether: thanks for having me. Really appreciate it. 

[00:23:57] Matt Halloran: As a business owner. [00:24:00] I’m sitting here taking notes. Uh, so listen, uh, even as just a passive participant on the show today, you know, a business owner, listener, this is the sort of stuff that you need to be sharing with your business owner friends, because if she hears this and understands that there’s a fundamental difference in how you might be able to file your taxes and such, your organization, I.

[00:24:18] Matt Halloran: Like Larry said, it can save so much. And this is the sort of stuff that we cover on the Life Unlimited podcast all the time. So please make sure that you like, share and subscribe to this show. And if there is a business owner you like, just click that share button and give them all of this great information.

[00:24:32] Matt Halloran: So for Larry and Bill, uh, this is Matt Halloran and we’ll see you on the other side of the mic very soon.