Although you top out SS right now at $142,800 and state unemployment bases are significantly lower than that, so its really just FICA taxes you save. With QBI at least for me it turns out the total wages part is what limits me, so I'm better off paying myself more in W-2 salary with the FICA tax to maximize the QBI deduction. However definitely highly idiosyncratic to your personal situation so ymmv.
Is paying an employee with real estate a legal loophole to avoid income tax?
- Thread starter kmgilroy89
- Start date
So, the way we do payroll is, if I'm paid 900k in one month then my income tax is taxed as if I make 900k*12=$10.8M per year. The entire social security tax is deducted. The entire 1.45 Medicare rate is used and then I'm at 2.35% on all income above 200k or whatever it is. My employer also pays FUTA and the Florida State Unemployment Tax which are relatively small.
Yeah, keeping it simple, if I can buy a $1M condo in Miami it would be like $3500/month in principal/interest, $1400 in property taxes, $400 per month in insurance, $1200 month in HOA fees. Let's say 1/4th of it I use as my home office. I don't know what percent is the principal first year, 30%? So if my logic is correct for a home office I would get to deduct 25% of the 250k above the 750k I can deduct interest, property tax, HOA, and insurance fees? So like (3500)(.25)(.25)+(.25)(1400+400+1200)=968.75 plus 25% of the mortgage on the first 75% of the $3500 which will be like 30% principal the first year. So like 196.88. So that'll be like $14k per year extra I can deduct. By deducting 14k off my income for my home office I only save 39.35% of it which is about $5500. Still not enough to pay for even the 1.45% in Medicare my employer has to keep paying. I think I'll stay W2.
It can be distributed out of the s-corp to the shareholder(s) immediately, or it can remain in the s-corp to further develop or expand the business. You pay regular income tax, or the special rate for capital gain, in the year in which the income is actually earned--regardless of when it is distributed to shareholders.
Accumulated earnings tax is generally applicable only to a c-corp, not an s-corp. C-corp is a whole different world. In a c-corp, the corporation pays tax on net profits, and then distributes those profits to shareholders as dividends--on Form 1099-DIV, not on Schedule K-1--and then the shareholders also pay tax on those dividends.
The basic concept here--at least for small businesses, including professional traders, is that no one expects a business--regardless of the type of entity (sole prop, s-corp, partnership, whatever)--to have a zero balance in the company checking account at the end of the year. Some profits are usually kept within the company, as a reserve for unexpected expenses in the following year, or with the intent to expand the business (e.g., opening a new location).
In an s-corp or a partnership, net profits are expressed on the Schedule K-1 issued to shareholders and partners, regardless of whether that money was actually distributed to them or held within the company. The shareholders and partners pay tax on all profits in the year they are earned. If some or all of the profits are kept within the company, then it is as if the money was distributed to them, and then they immediately turned around and made a capital contribution to the company in the same amount. In the year-end accounting process, retained profits have the effect of increasing the partner's or shareholder's basis. The money becomes available for distribution in a future year as a tax-free return of capital.
BMK
The basic concept here--at least for small businesses, including professional traders, is that no one expects a business--regardless of the type of entity (sole prop, s-corp, partnership, whatever)--to have a zero balance in the company checking account at the end of the year. Some profits are usually kept within the company, as a reserve for unexpected expenses in the following year, or with the intent to expand the business (e.g., opening a new location).
In an s-corp or a partnership, net profits are expressed on the Schedule K-1 issued to shareholders and partners, regardless of whether that money was actually distributed to them or held within the company. The shareholders and partners pay tax on all profits in the year they are earned. If some or all of the profits are kept within the company, then it is as if the money was distributed to them, and then they immediately turned around and made a capital contribution to the company in the same amount. In the year-end accounting process, retained profits have the effect of increasing the partner's or shareholder's basis. The money becomes available for distribution in a future year as a tax-free return of capital.
BMK
The home office deduction does not allow a deduction for the principal portion of the mortgage. You get to deduct a percentage of the interest, insurance and property taxes, plus a percentage of utilities, and in some cases certain types of repairs and maintenance.
You also get a deduction for depreciation, which is a percentage each year of the cost of the building (not including the cost of the land, which would not be applicable anyway in the case of a condo).
There is an optional method for computing the home office deduction that involves a dollar amount based on square footage.
As a W-2 employee of a prop firm, you will never get the benefit of the 20% QBI deduction. That is potentially valuable, and might be a good reason to consider switching to 1099/Schedule C or s-corp.
BMK