Tax, Investing, and Legal Strategies for Medical Professionals

High-earning medical professionals eventually learn a hard lesson: the more they earn, the more they pay in income taxes.

And since physicians and other medical professionals rank among some of the highest-paid individuals in the United States, they need tax planning and investment strategies that will protect their assets and build real generational wealth they can pass to their children and grandchildren.

Hard-working doctors and other healthcare pros can take advantage of all the tax deductions, tax credits and tax exemptions that Congress and the Internal Revenue Service (IRS) make possible to reduce their taxable income.

But there are also lesser-known strategies which, when leveraged correctly, can reduce your tax burden and deliver a sound financial plan that gives you what we call “time freedom.”

These include:



✅️ Setting up an S-Corporation and a Solo 401(K)
✅️ Setting up a 501(C)3 Non-Profit Private Foundation and investing in cash flow deals 
✅️ Investing your tax savings in Short-Term Rentals or syndication deals that offer bonus depreciation

Here I’ll introduce some of the tax, investing and legal strategies our medical professional clients use.

Tax Strategies for Medical Professionals

As a busy healthcare professional, you work hard to provide quality care to your patients, juggle administrative work, and balance your work with life and demands at home. 

That’s why working to optimize your tax situation is probably not at the top of your priorities.

Deep down, however, you know that tax planning should be a key component of your wealth management strategy.

If you are employed by a hospital, a private practice, or a government healthcare department, you’re probably a W2 worker. W2 employees are taxed on gross income first, meaning the IRS takes their cut before you receive your paycheck.

But if you’re a business owner or investor (with the correct structures in place), you can pay the IRS quarterly on your net income after expenses. 

To put it another way, when investing through a properly structured entity, your investment income gets the same tax treatment as a business. This allows you to use your money before deducting taxes. 

If you’re like most of our clients, you've been told there isn't much you can do to lower your taxes beyond taking deductions or using retirement vehicles like 401ks and IRAs. 

This simply isn’t true.

That’s why finding the right CPA to work with is so crucial. You need someone who knows what they’re talking about. It's important to understand there are different tiers of CPAs:

Many CPAs don’t understand that it's possible to save outside the standard deductions. A high-level CPA is someone who earns a high income themselves, someone who has personally found a way to pay nearly $0 in tax by leveraging advanced strategies. 

The right CPA helps our medical professional clients achieve and maintain tax rates in the 0-10% range. This accelerates your overall cash flow and net worth.

If you find a CPA with an MBA and who can perform Chief Financial Officer functions, even better— these folks will be able to help you navigate complex tax decisions and make it seem easy.

When you work with that level of CPA, you'll start to find creative (but completely legal) ways to save taxes, even if you're a medical professional with zero investment experience. And that savings can be invested in equally creative, equally overlooked ways.

Such as …

Investing Strategies For Medical Professionals

The median wage for medical professionals (everything from dental hygienists, physicians and surgeons, to registered nurses) was $80,820 in 2023—much higher than the median annual wage (for all occupations) of $48,060. (Source)

However, at a certain point these high-salary professionals realize they need to take steps to shelter their income from overtaxation. And while saving money on tax is important, but the real magic happens once our medical professionals start re-investing those tax savings into tax advantaged deals.

These include:

Private Foundations

A Private Foundation is a self-funded nonprofit organization that shelters income, allowing you to bypass traditional capital gains tax and take advantage of a much lower excise tax rate.

When using the Private Foundation for income sheltering and high-performance investments, the compounding effect can lead to much better returns than traditional investing.

The Private Foundation can even  replace your W2 income with a director’s salary for managing the Foundation.

Depreciation Deals

Bonus depreciation is a tax incentive designed to stimulate business investment by allowing investors to accelerate the depreciation of qualifying assets, such as equipment, rather than write them off over the useful life of the asset. This strategy can reduce a company's income tax, which in turn reduces its tax liability.

Medical professionals can claim accelerated bonus depreciation as a limited partner when investing passively into a real estate syndication. As a limited partner (LP) passive investor, you get a share of the returns based on how much you invest. 

Similarly, you get a share of the tax benefits as well, as documented by the Schedule K-1 you would receive each year. The K-1 shows your income for a particular asset. In many cases, particularly in the first year of the investment, that K-1 can show a loss instead of an income.

The magic of the K-1 is that it includes accelerated and bonus depreciation. In other words, even while you’re receiving cash flow distributions, the K-1 can show a paper loss, which in most cases means you can defer or reduce taxes owed on the cash flow you’ve received.

Cash Flow Deals

These deals don't offer tax benefits, but can generate so much income that they outperform potential tax savings. Investments in this category include things like self-storage and algorithmic trading. You can invest in cash flow deals through a tax shelter, such as your Private Foundation, to get the initial tax savings as well as tax advantaged portfolio growth.

Legal Strategies For Medical Professionals

Estate planning is something everybody needs to do at some point. Lawsuits can happen to anyone, and high-net-worth medical professionals are especially at risk. All it takes is a car accident, an injury on your property, a contractual disagreement—and once somebody knows what you own, they can hire a good attorney to force you to settle out of court. 

The way you protect yourself is to set up asset protection. Holding companies can shield anything of value, such as real estate properties and investments. Operating companies can be established for  business activities like collecting rent, paying contractors, and signing contracts.

Trusts are a way to guarantee anonymity across all of your entities and assets. They allow you to look like a beggar on paper and transfer your assets anonymously to your heirs, taking the target off your back.

Here are a couple of other legal structures we help our clients set up:

S Corporations

Independent doctors or physicians can create S Corporations to handle their taxes. Unlike regular corporations (where profits get taxed twice), S corporations pass their income, losses, and deductions directly to their owners. An S Corp, or S corporation, is a “pass-through” entity, which means that the profits and losses of the business are passed through to the individual owners and are taxed at the owners’ personal income tax rates. 

Instead of paying corporate taxes, each owner reports their share of the business’s money on their personal tax returns, paying taxes at their individual rates.

Solo 401(K)

What about retirement?

If you are a medical practitioner who works as an independent contractor, The Solo 401(k) is an ideal retirement plan because it lowers your taxable income and enables you to build up retirement funds through high contribution limits and almost limitless investment capability. 

The Solo 401(k) is a qualified retirement plan, just like hospital-sponsored plans. You can contribute to the plan on a tax-deferred basis. You can also contribute Roth funds to the plan and invest tax-free. With some of the highest contribution limits, the Solo 401(K) lets medical professionals lower their taxable income and grow their retirement quickly. 

To Wrap It Up …

Even medical professionals with no investments need entity structuring. Here is what a full legal diagram could look like, which includes asset protection structures, estate planning, and tax shelters.

As you accelerate your tax and investing approach, it's important to add in measures to prevent a catastrophic reset. We can show you how to save $20k or more in taxes during the first year, but you will want to set up additional tax and legal structures over time to continue to reduce your taxes down to the 0-10% range. 

Without entities, this would be impossible.

It's also important to protect yourself from catastrophic events, no matter how unlikely, so that you don't have any major setbacks on your journey to time and financial freedom.

How To Take Money Out Of Your S Corp

If you’ve formed an S Corp to manage your real estate investments, you probably already know about the benefits that come with S Corp taxes. In fact, the primary difference between S and C corporations is the way the businesses are taxed:

That’s the beauty of an S Corp compared to a C Corp. C Corp income is taxed twice: once at the corporate level, and once at the individual level (as a dividend). S Corps avoid this double taxation by passing all of their income through to their owners. The business doesn’t pay taxes; only the owners do.

Whether you’ve started a corporation, an LLC, or a series LLC, you can elect to be taxed as an S Corp. If you’ve gone this route, congratulations! You’ve made a great economic decision that can save you some serious dough that would otherwise go to Uncle Sam. Now the question is: how do you take the money you earn out of your S Corp? 

 

Take Money Out Of Your S Corp: Cash Register

3 Methods: S Corp Distributions, Loans & Personal Salaries

In addition to tax benefits, a major advantage to forming a corporation is the protection it offers your personal assets in case the business gets sued. You should never use business money to pay for personal expenses; you could lose the protection of the corporation in the event of a lawsuit because you have commingled assets.

So how do you access the money that your S Corp makes? I’m assuming you didn’t start a business for your health: you’re doing it to make money to cover personal expenses.

If you want to take money out of your S Corp, you have three options:

Take S Corp Distributions

Distributions are the best way to get money from your S Corp. Because you’ll report it as “passive income” on your income tax return, it won’t be subject to employment taxes. This saves you money! 

Because S Corps are pass-through entities, you have to report your business’s income on your personal return whether you actually receive it as a distribution or not. The upside of this is that you won’t have to pay additional taxes on a distribution unless it constitutes a capital gain. A lawyer or tax accountant can help you determine the most advantageous way to take your distributions.

Transfer Money From the S Corp to Your Personal Account

Unfortunately, Uncle Sam won’t let you take all of the money out of your S Corp as distributions, because the government wants your tax money. For this reason, the IRS requires that you pay yourself a “reasonable” salary for your contributions to the company. You should try to minimize the amount of salary you take while still meeting the “reasonable” standard.

True to form, the IRS doesn’t give any specific guidance as to what “reasonable” means. Some factors that courts have considered when deciding whether a salary is reasonable include:

Another way to look at it is to pay yourself what you would pay somebody else to do your job.

Give Yourself A Loan From the S Corp

When you’re taking money out of an S Corp other than your salary, you can set up a line of credit between you and your business. Then, you’ll take cash out as a loan against that line of credit. At the end of the year, you and your accountant can decide if you should convert some of that loan to a distribution or leave it as a loan (you’ll need to pay interest on the loan). If you borrow money from the corporation (via a loan), you’re never going to have capital gains. 

However, even if you list your withdrawal of funds as a loan on your financial statements, the IRS can recharacterize it as a distribution. If Uncle Sam recharacterizes your loan, you’ll have to pay income taxes on it just as you would a distribution.

If you take out a loan from your S Corp, you need to dot your i’s and cross your t’s to make sure it stays characterized as a loan. For example, creating a legally enforceable promissory note helps prove that the transaction was actually meant to be a loan. Before you take a loan from your S Corp, you should seek advice from your lawyer and your accountant.

Successfully Investing in Real Estate as a Married Couple

You've chosen a life partner and are married. You may be asking yourself, is it wise to make my spouse my business partner? The answer could be yes. You would want to be sure to have a game plan in place. Good communication would also be necessary to balance the commitments of your marriage and business. Real estate investing as a married couple can be a very rewarding and lucrative endeavor.

In this article, we discuss:

Keep reading to develop a solid plan that safeguards your marriage and business.

Benefits of Real Estate Investing as a Married Couple

First, let's talk about why operating a business that involves real estate investing as a married couple is a good idea:

You and your spouse will share financial goals in your business. For instance, there will not be interoffice politics to navigate, and you will both work to secure your financial freedom.

Working with someone you trust, like your spouse, there is also peace of mind. Since you trust your spouse, the business will benefit from your stability and commitment to your marriage and the company.

Before You Start Real Estate Investing as a Married Couple

Before you dive into a real estate business with your spouse, you should discuss:

After you answer these questions with your spouse, make sure to write your decisions down. Having these agreements in writing protects both of you in the event of:

No one wants to think about the bad things that can happen in a marriage, but those adverse events have ramifications for your business. That's why it's essential to have plans "just in case" different types of scenarios occur.

Options for Running Your Real Estate Investing Business as a Married Couple

In general, the IRS allows for four different types of business structures:

Did you decide that only one spouse will be an owner? You might choose to create a sole proprietorship or a single-member LLC.

Are both you and your spouse going to be owners? You will most likely choose either a partnership, LLC, or a corporation.

Sole proprietorship

The following conditions must be met to be a sole proprietorship:

Taxes on a sole proprietorship, each spouse must file:

Considerations for running your business as a sole proprietorship:

If you want more detailed information about this business structure, check out our article, "Can My Husband And I Own Our Business Together As A Sole Proprietorship?"

Partnership

Typically a partnership:

Taxes on a partnership:

Considerations for running your business as a partnership:

Read up on how a Limited Partnership can structure your real estate and other business deals in "Limited Partnership for Real Estate Investors" to see if this structure will work for you.

Limited Liability Corporation (LLC)

You will want to check your Secretary of State web page for more details, but in general, to form an LLC:

Taxes on an LLC:

Considerations for running your business as an LLC:

If you want to learn more about how LLCs protect you, your spouse, and your assets, read "What Are The Different LLC Types USe By Real Estate Investors?"

Corporation

This business structure is a separate entity from either your or your spouse. In general, a corporation:

Taxes on a corporation:

Considerations for running your business as a corporation:

Final Thoughts

Real estate investing as a married couple can be a massive advantage for both of you. You can secure your financial future together and reduce your tax burden. However, it's essential to know how to maximize your savings as a real estate investor.

For more information about how to keep more of your hard-earned money, read the following articles:

Consider attending our FREE weekly group mentoring calls if you are just starting with real estate investing as a married couple. During these calls, we discuss topics such as: how to best structure your business, how to protect your assets, what tax savings you can take advantage of, and more. Join us for Royal Investing, Wednesdays at 12:30 p.m. EST by Registering Today.

S Corp Distributions: The Nitty-Gritty

The sad truth is that every year, we have to file and pay our taxes.

While it definitely is a pain in the neck, it can also be an opportunity to evaluate your financial progress for the year. The goal for taxes is almost always to maximize your deductions while minimizing taxes, but often this is easier said than done.

One way savvy real estate investors can reduce their tax bills without running afoul of the IRS is by paying themselves as much as possible through S Corp distributions. If you want to learn more about the nitty and the gritty of S Corp distributions, read on.

s corp distributionsWhy Real Estate Investors Love S Corps

S Corps are considered a “pass-through” entity for tax purposes. This means that the business is not required to pay corporate income taxes. Rather, the profits and losses for the business are distributed to the owners and reported as their personal income.

This is a tremendous advantage over C Corps, which is the default tax status for a corporation. Any income that a C Corp makes is double-taxed: once at the corporate level and again on the individual owner’s income tax return. Designating your business as an S Corps allows your company’s profit to only be taxed once. 

You can also use an S Corp to reduce the burden of payroll and self-employment taxes. We’ll get more into this in a little bit. For now, just know that real estate investors often take advantage of these S Corp tax benefits.

However, S Corps will not be suitable for every investor. Due to the costs associated with an S Corp, it usually only makes sense for investors who are earning at least $50,000 annually from their business. If you’re making less than that, the costs of setting up and maintaining an S Corp will probably outweigh your tax savings. Talk to your CPA or a business lawyer to learn whether an S Corp can work for you. Or you can fill out our quick investor quiz and get the help you need.

s corp distributionsWhat Is An S Corp Distribution?

If you’ve never heard of an S Corp distribution before, prepare to meet your new best friend! An S Corp distribution is your proportional share of the S Corps earnings for the year, based on the number of shares you own. It’s the best way to take money out of an S Corp. 

If you’re the sole owner of your S Corp, you’ll just get 100% of the income. But if there are multiple shareholders, the earnings will be distributed on a per-share basis. The total earnings will be divided by the number of shares, and each shareholder will receive the same amount per share. So, while the shareholders might not all receive the same total amount, they must each receive an equal per-share payout.

For example, say an S Corp has issued 100 shares as follows:

So, if the business made a profit of $1 million, this is how the dividends would be distributed:

Limitations On Distributions

What’s great about distributions is that it’s considered “passive” income, which isn’t subject to payroll taxes. However, the IRS won’t let you skip out on payroll taxes altogether. 

Before you can receive any distributions, you’ll have to pay yourself a “reasonable” salary for your contributions to the business. The secret to maximizing your tax savings is to pay yourself the lowest reasonable salary possible and taking the rest of the profits as a distribution.

The IRS doesn’t provide any direct guidelines for how to determine if your salary is reasonable, but some factors to consider include:

If you set your salary too low, the IRS might reclassify some of your distributions as salary, which can lead to penalties and additional taxes. The best way to avoid scrutiny is to consult with your CPA or attorney before setting your salary.

Why Do Independent Contractors Love the S Corps? Short Answer: Lower Taxes!

Independent contractors and real estate investors love S corporations (S corps). That's because an S corp provides significant advantages over sole proprietorships or traditional corporations—both in terms of limited liability and reduced taxation.

Introduction to S Corporations

An S corp is not a separate type of business entity. Rather, it is a designated tax status for businesses that meet these criteria:

An S corp otherwise follows all the other requirements of a traditional corporation. It has a board of directors, drafts corporate bylaws, has shareholder meetings, and keeps meeting minutes of company meetings.

Why Do Independent Contractors Love the S Corps? Short Answer: Lower Taxes!

Advantages of S Corporations For Independent Contractors

Compared to sole proprietorships and traditional corporations, S corps have several benefits, including lower taxes and reduced legal liability.

To receive these benefits, the corporation must register as an S corp. You'll do this by filing IRS Form 2553. This form essentially states that the corporation meets the requirements listed above and that all shareholders consent to the registration.

Reduced Legal Liability

If you operate as a sole proprietorship and get sued, all of your personal assets are at risk. For example, assume you do business as a sole proprietorship and own $200,000 worth of real estate at 100 North Street. You also have $6.2 million in other personal assets.

If you get sued as a sole proprietor, all of your assets ($200,000 + $6.2 million = $6.4 million) could be subjected to liability. However, assuming your S corp is in good standing and complies with all legal requirements, if someone sues you for an issue related to the property at 100 North Street, your liability could be limited to $200,000.

Taxation Benefits

S corps have huge taxation advantages because business income passes directly to the shareholders. There’s no separate corporate tax—only the shareholders are taxed. This is known as the “pass-through” concept and is a distinct advantage over sole proprietorships and traditional corporations.

For the independent contractor or self-employed real estate investor, this means that you are the owner and employee of the company. As an employee, you pay yourself a reasonable salary and are taxed on that - while the S corp itself pays no taxes.

Before discussing the advantages of an S corp over a sole proprietorship or traditional corporation, you need to understand what constitutes a reasonable salary.

How The Self-Employed Determine 'Reasonable Salary'

An S corps’ shareholder-employee must be paid a reasonable salary as compensation. It is treated as employee wages for tax purposes. The IRS requires the salary to be reasonable because it pays the self-employment tax (i.e., it funds Social Security and Medicare). Check out our article, Using Your S Corp: Payroll Taxes for the skinny.

It is critical to get the reasonable salary right because the IRS will be taking a close look—trust us on this. Fortunately, the IRS has published factors to consider when determining the appropriateness of a salary. IRS Form FS-2008-25 provides these factors, listed verbatim here:

There are other factors as well, but they only become relevant when the S corp has multiple employees. For the individually-owned S corp, which is typical of many independent contractors and real estate investors, these do not apply.

There are many rules of thumb for estimating reasonable compensation. Presented in terms of salary per total business profits, they range from 33:67 to 50:50 to 60:40. However, instead of relying on generic guesses, we recommend hiring a certified public accountant or lawyer to estimate the percentage of business profits devoted to salary.

Here’s are examples of how S corp taxation works compared to sole proprietorships and traditional corporations.

S Corporations Vs. Sole Proprietorships

Let’s assume you are an independent contractor or a real estate investor with a sole proprietorship. Last year, you made $100,000 in profits. As a sole proprietor, you pay a 15.3 percent self-employment tax, or $15,300, in taxes.

Now let’s assume that you have an S corp, and you’ve worked with your accountant or lawyer to arrive at a reasonable salary of $60,000. In this case, because the S corp profits themselves are not taxable, you would only pay the self-employment tax on your salary. That would be $60,000 x 15.3 percent = $9,180. So, being structured as a corporation with S corp registration, instead of a sole proprietorship, would save you $15,300 - $9,180 = $6,120 in federal taxes.

S Corporations Vs. Traditional Corporations

A traditional C corporation not registered as an S corp would pay federal taxes on both the corporation’s profits and the employees’ salaries. This likely would be significantly more than the amount paid solely by an S corp employee.

To learn more, check out our article Series LLCs and S Corporations: Which Is Best For Your Business?

Conclusion

If you are an independent contractor or real estate investor, consider structuring your business as a corporation registered with the IRS as an S corp. Our legal experts at Royal Legal Solutions can discuss your options, including the calculation of a reasonable salary under an S corp ... So don't hesitate to reach out if you have any questions about this strategy!

Using Your S Corp: Section 179 Deductions

If the title of this article is already making you yawn, I promise—this will be more exciting than you think. Why’s that? Because this article is all about SAVING YOU MONEY BY LOWERING YOUR TAXES.

Save Money? Lower Taxes? Tell Me More!

Now that I have your attention, let’s dive in. Using a Section 179 tax deduction with your S Corp allows you to deduct the full purchase amount of business equipment from your personal taxable income.

When a Section 179 deduction is personally allocated to you from an S Corp or partnership, the income and expense are “passed through” to you, and you claim it on your individual tax return. This means any income you earn from your S Corporation will be reduced by your Section 179 deductions, and you’ll only have to pay taxes on the reduced amount. 

Let’s look at an example to see how this would play out in real life:

Tom is a real estate investor who started an S Corp to hold his investments. He earned $100K in 2020 through the S Corp. Since an S Corp is a pass-through entity, Tom would typically have to pay personal income taxes on the $100K the S Corp made. However, if Tom has $20K of Section 179 deductible expenses, he’d only have to pay personal income taxes for $80K. 

Pretty spiffy, right?

s corp section 179How Section 179 Works

Section 179 gets its name because the rule is found in section 179 of the Internal Revenue Code. Essentially, this rule allows you to write off the full cost of eligible Section 179 property in the year it is purchased and put into use instead of deducting the depreciation over time.

This means you cannot take a 179 deduction on property purchased in a previous year, even if this is the first year you used the property for business purposes. For example, if you bought a vehicle for personal use in 2019, then converted it to a company car 2020, you cannot use a Section 179 deduction.

What You Can and Can’t Deduct

Property eligible for the Section 179 deduction is usually tangible personal property (usually equipment or office furniture) purchased for use in your business. 

Some common examples of Section 179 qualifying property include:

However, certain types of depreciable property are NOT eligible for a Section 179 expense deduction. Ineligible property includes:

Additionally, if you use property for both personal and business purposes, you can only use a Section 179 deduction if the asset is used at least 51 percent of the time for business. 

Section 179 Deduction Limitations

The total amount of purchases you can write off changes every time Congress updates IRC section 179 of the tax code. As of 2020, the maximum Section 179 expense deduction is $1.04M. 

In addition, this limit will be reduced by the amount by which the cost of Section 179 eligible property placed in service during the tax year exceeds $2.59M. This means if your business purchases and puts into use $2.6M, you’ll only be able to deduct $1.03M of these expenses using Section 179. The $10K overage on the $2.59M limit will reduce the $1.04M limit by $10K.

As a small business, I know you probably won’t come anywhere close to this amount of Section 179 expenses. But it’s always a good idea to know the rules, just in case.

Business Vehicle Deductions

People used to refer to Section 179 as the “Hummer Deduction” or the “SUV Tax Loophole” because many businesses took advantage of these deductions to write off the full purchase price of expensive vehicles. In response, the IRS severely reduced allowable write-offs for business vehicles. As of 2020, the maximum section 179 expense deduction for sport utility vehicles is $25,900.

Bonus Depreciation

If you can't write off an asset immediately, you have to depreciate it. You deduct a percentage of the value each year until you've written off the entire cost. 

It's also possible that you can take off extra for expenses that exceed the Section 179 limit, the first year as "bonus depreciation." Through 2022, the amount of bonus depreciation you can claim is 100%. 

Starting in 2023, bonus depreciation rates decrease to:

When you use Section 179 deductions with your S Corp, you can save a ton of money in taxes. Make sure you keep track of everything you buy for your business and GET THOSE DEDUCTIONS!

Interested in learning more? Check out our articles Using Your S Corp: Payroll Taxes and Getting The Most Out of Employee Business Deductions.

Using Your S Corp: Payroll Taxes

As we continue our series on S Corps, we’ve come to an interesting question: Does an S Corp need to pay payroll taxes? Your short answer is yes. S Corps, even single-member ones, are responsible for payroll taxes just like any other business. However, one of the fantastic benefits of an S Corp is that you can avoid payroll taxes for at least some of the money you make.

What Are Payroll Taxes?

The term “payroll taxes” refers to the Social Security and Medicare taxes that are withheld from an employee's paycheck and matched by employers. 

Here’s how it works:

s corp payroll taxesWhat Is Self-Employment Tax?

If you own your own business as a sole proprietor, you’ll have to pay self-employment tax. Since you essentially are your own employer, you have to pay both the employee and the employer’s share of payroll taxes. This means that you have to pay 15.3% of your income in self-employment taxes to ensure your share of Medicare and Social Security taxes is covered. 

A quick note: self-employment taxes and payroll taxes both refer to Medicare and Social Security taxes. They’re just called different names depending on how they are paid, because people like tax law to be unnecessarily confusing.

Payroll Taxes And Your S Corp

This is where having an S Corp comes in handy. With an S Corp, you can avoid payroll taxes on any profits you make from your business, as opposed to a sole proprietorship – where you have to pony up payroll taxes for 100% of your earnings. 

Here's the catch: you can’t just call all of your earnings profits, skip payroll taxes altogether, and call it a day. The IRS requires that, if you work as an employee of your S Corp, you have to pay yourself “reasonable” compensation for your services. 

What Is 'Reasonable' Compensation?

That’s a great question! Unfortunately, there’s no great answer. Reasonable compensation isn’t defined anywhere in the tax code. Instead, the IRS will look at the facts of your particular circumstances to determine if your salary is reasonable. If they think your compensation is too low, they can recharacterize your distributions as wages, and you’ll have to fork over payroll taxes.

In deciding whether compensation is reasonable, the IRS (and the courts, for cases that go to litigation) will look at factors such as:

In general, the more qualified you are and the more professional services you provide for your S Corp, the higher your salary should be. You definitely want to seek guidance from your attorney or account on this issue because the IRS is notorious for its thorough scrutiny of S Corp salaries and distributions.

Payroll Taxes On Your Compensation

If you’re paying yourself (salary or wages) and you’re an employee of your S Corp, payroll taxes must be withheld just like any other employer. The S Corp will pick up the employer’s share of payroll taxes, and your share will be deducted from your pay. This means you can’t benefit from the S Corp’s magic payroll-tax-avoiding powers until your business is lucrative enough to pay yourself a reasonable salary AND have some profits left over.

Another thing to keep in mind: If you have a health insurance policy through your S Corp, make sure your S Corp is footing the bill. That means the S Corp will have to add your insurance payments as income on your W-2. 

Qualified Business Income Deduction

The qualified business income (QBI) tax deduction lets you deduct up to 20% of your S Corp income on your taxes. Of course, the IRS has put plenty of limitations on who can use this deduction and what type of business income is covered.

What Is Qualified Business Income?

The IRS defines qualified business income as “the net amount of qualified items of income, gain, deduction and loss with respect to any trade or business.” In other words, it’s your S Corps net profits.

This means you can take a QBI deduction on the PROFITS of the S Corp you receive as distributions. You do not get to use the QBI deduction on the SALARY you pay yourself. 

QBI Income Limits

In 2020, your total taxable income must be under $163,300 for single filers or $326,600 if you file jointly with a spouse.  In 2021, the limits will increase a bit to $164,900 for single filers and $329,800 for joint filers.

Remember — since your S Corp is a pass-through entity, you’ll report its income as your own on your personal income taxes. So these limits apply to your TOTAL taxable personal income and not just the part that comes from your S Corp.

If you’re over the income limit, you may still qualify for a full or partial deduction. But these laws are immensely complicated and confusing, so it’s best to contact your accountant or lawyer to discuss if you qualify.

 

Interested in learning more? Check out our article How You Can Save Thousands in Taxes with an S-Corp and Using Your S Corp: Section 179 Deductions.

 

 

Self Employment Tax & The Independent Contractor

Paying taxes as an independent contractor can be a pain. The purpose of this article is to make it easier for self-employed individuals (such as real estate agents, brokers, and investors) to understand, calculate and plan for paying Uncle Sam the self-employment tax he is owed.

What Is An Independent Contractor?

An independent contractor is essentially a nonemployee, meaning a person or business entity that provides products or services to other businesses and is in business for themselves. This is in contrast to an employee, who works for an employer and is paid a certain wage or a salary.

Sounds pretty obvious, right?

According to the National Association of Realtors, there are about 2 million independent real estate agents and brokers in the United States. Each one of these individuals is a self-employed business owner, considered an independent contractor.

The Internal Revenue Service (IRS) has declared that real estate agents are "statutory nonemployees" for tax purposes. As such, they are considered self-employed and subject to self-employment tax, just like any other independent contractor.

What Is Self-Employment Tax?

Self-employment tax consists of Social Security and Medicare taxes for self-employed individuals. It is equivalent to the Social Security and Medicare taxes that employers are required to withhold from their employees’ paychecks.

Think of it this way: If you were working for an employer, you would have a certain amount of money withheld from your paychecks for Social Security and Medicare taxes. What you may not know is that your employer would also have to pay that same amount on the wages you receive.

Those required to pay self-employment tax include:

Independent contractors are responsible for paying both the employee's and the employer's portions of self-employment tax on their earnings. Also, rather than having the tax withheld from multiple paychecks throughout the year, independent contractors must pay self-employment tax as a lump sum, along with their income tax return in the spring, or by making estimated quarterly tax payments throughout the year.

Self-Employment Tax & Real Estate Investors

Investing in real estate is one of the best ways to create wealth and enhance your cash flow. For passive income investors, your rental income is not subject to self-employment tax. However, if you do several real estate transactions in a year, the IRS might consider you to be doing active business or trade rather than simply enjoying passive income from your real estate investments.

While the IRS treats everything on a case-to-case basis, if you earn more than half of your total income through real estate investments, the IRS may consider your earnings to be a source of earned income rather than passive income. Earned income is subject to self-employment tax and higher income taxes.

How you legally structure your investment activities can also affect how your investment income will be taxed. For example, investing in real estate as a C corporation, and paying yourself a management fee or salary can also trigger self-employment tax and higher income taxes.

How To Calculate Self-Employment Tax?

You calculate self-employment tax on Schedule SE (Form 1040). To do so, you must take 92.35% of your total net earnings (gross earnings minus any deductions) and multiply that figure by the current self-employment tax rate.

Currently, the self-employment tax rate is 15.3%, which is a combination of 12.4% Social Security tax plus the 2.9% Medicare tax. Therefore, the formula for self-employment tax is as follows:

SE Tax = (net earnings) x (92. 35%) x (15.3%)

For example, if you earn $10,000 in self-employment income in 2020, you will pay approximately $1,412 in self-employment tax ($10,000 x 0.9235 x 0.153 = $1,412.955). Likewise, if you earned $50,000, you would pay $7,064.775 in self-employment tax ($50,000 x 0.9235 x 0.153 = $7,064.775).

How Do I Pay Less Self-Employment Tax?

Self-employment tax can be a hefty price to pay for doing business as an independent contractor. The only way to reduce your self-employment tax is to reduce your self-employed income.

Shockingly, the IRS allows independent contractors to deduct a wide range of valid business expenses on Schedule C (Form 1040). Knowing what these deductions are and keeping good receipts and records can save you thousands of dollars.

Common expenses that can be deducted on Schedule C include:

Other expenses that individuals often forget to deduct on Schedule C are:

Your self-employed income and expenses are reported on Schedule C. The result of that form is the total self-employed income that gets transferred to the Taxable Income line on your 1040.

Why Become An S Corporation?

If you are an active real estate flipper or wholesaler, you are more than likely subject to self-employment tax. But you can save thousands in taxes by electing to be taxed as an S Corporation.

S Corporations (and LLCs that have elected S Corporation tax treatment) can be structured to minimize or avoid self-employment tax entirely. Also, as an S Corporation, you will not be obliged to pay federal income tax or corporate taxes.

For instance, you can structure your S Corp so that you only pay self-employment tax on a fair salary that you pay yourself, rather than on your corporation’s net earnings. Moreover, any distribution you pay yourself from the S Corporation will be completely exempt from self-employment tax.

Budgeting For Self-Employment Tax

As a rule, whenever you have income from sources other than a salary or wages, and you expect to owe $1000 or more when you file your tax return, you need to make estimated quarterly tax payments to the IRS to avoid penalties, interests, and a sizable tax bill at the end of the year. While it is best to consult with a tax professional to determine your quarterly tax payments, there are steps you can take to budget for your self-employment tax obligation:

Set Money Aside

After accounting for self-employment tax, set aside at least one-third or even as much as 45% of all your earnings in a dedicated savings account. This will help ensure that you have enough to make estimated tax payments each quarter.

Track Your Expenses

Remember, self-employment tax is paid on your net earnings, meaning the amount you have left over after you have accounted for all your expenses. So, be sure to keep accurate records of all your expenses to ensure that you are not paying more taxes than necessary.

Pay On-time

If you must submit estimated tax payments each quarter, make sure that you submit them on time to avoid penalties.

Consult With A Qualified Tax Professional

A qualified tax professional can help you determine what your self-employment tax liability will be and ensure that you pay your taxes on time. With the right preparation and advice, you will not be caught off guard when tax season rolls around.

Keep more of your money with a Royal Tax Review

Find out about the tax savings strategies that you can implement as a real estate investor or entrepreneur by taking our Tax Discovery quiz. We'll use this information to prepare to have a productive conversation. At the end of the quiz, you'll have an opportunity to schedule your consultation.    TAKE THE TAX DISCOVERY QUIZ

What’s The Difference Between An S Corporation & A C Corporation?

If you’re trying to set up a business to hold your real estate investments, all the jargon and legal mumbo jumbo can be confusing. For instance, the internet is probably telling you to decide if you want your business to be an “S” corporation” or a “C” corporation,” but you don’t even know the difference between an S Corp and a C Corp. So how are you supposed to decide?

Don’t worry—I’ve got your back. Think of this article as your starter guide to deciding how your business should be structured and taxed.

Before you can choose between an S Corp and a C Corp, you need to understand the basics of how businesses are classified. 

There are two different levels of classification:

First, you’ll need to choose the type of legal structure you want your business to have (corporation vs. LLC), and then you’ll select how you want to be taxed (S Corp vs. C Corp).

difference between s corp and c corp girl walking down pathFirst Level of Business Classification — Legal Structure

State laws will control the process of forming a corporation or LLC. When you start a business, you’ll need to decide if you want to be a corporation or an LLC, which controls your business’s legal structure and has nothing to do with how it will be taxed.

Corporation

A corporation is a business entity that is legally considered to be entirely separate from its owners. Real estate corporations can be held liable for corporate actions and earn profits that are considered the business’s income and not the owners. 

Generally, corporations are:

Limited Liability Company

Like corporations, a Limited Liability Company (LLC) is also a separate legal entity from its owners. However, real estate LLCs provide more flexibility in management options and fewer record-keeping requirements.

LLCs are:

Side note: If you’re starting your business to hold multiple real estate investments, you may want to consider forming a series LLC, which allows you to hold your investments in separate “series” within the same LLC for maximum asset protection and convenience.

Should Your Business Be An LLC Or A Corporation? 

Whether an LLC or corporation is a better structure for your business depends on various factors, including your goals for your business and your desired management structure. You should consult with an experienced business attorney when deciding which type of entity is best suited to your ambitions.

Second Level of Business Classification — Tax Status

Once you’ve decided on a legal structure for your business, you’ll also have to choose how you want to be taxed: S corp or C Corp? Both corporations and LLCs have the opportunity to choose between the two tax statuses.

C Corporation

The IRS acknowledges C Corps as distinct taxpaying entities. This means that if you go with a C Corp, your business’ profits will be taxed like "personal income" of the corporation. You’ll have to file a tax return for the company each year. Any portion of the profits distributed to the owners will be taxed again as their personal income.

S Corporation

S Corps are what is known as “pass-through” entities. This means that S Corps themselves don’t pay taxes. Instead, the company’s profits (or losses) are passed through to its owners for tax purposes. 

Each owner will include their portion of the company's profits and losses on their personal tax returns and pay taxes based on their individual tax bracket. Additionally, S Corp distributions are not subject to Social Security taxes as long as you’re paying yourself a reasonable salary. Because of the advantages offered by S Corp taxes, many real estate investors elect this tax status for their businesses.

Default Tax Statuses

The IRS will assign a default tax status to your corporation or LLC if you don’t tell them that you want them to do something different. What your default tax status is depends on the type of entity you formed and how many owners there are. 

Default Tax Status For Corporations

When you form a corporation, the IRS will automatically consider you to be a C Corp.

Default Tax Status For LLCs 

When it comes to taxes, there’s no such thing as an LLC. By default, single-member LLCs will be treated as sole proprietorships, and LLCs with two members or more will be treated as partnerships. The LLC will be viewed as a "disregarded entity" and will not be taxed.

How To Change Your Default Tax Status

If you form a corporation and decide you’d prefer to be taxed as an S Corp than a C Corp, you can file Form 2553 with the IRS to change your corporation’s tax status. Similarly, LLCs can file Form 8832 and choose to be taxed like an S Corp or C Corp.

S Corp Versus C Corp

So, you can elect to be taxed as either an S or C corporation. Why would you choose one over the other? 

In short: If you are going to bleed your company dry, an S Corp may be better. If you are building a business and need to leave funds with the company to grow the business, a C Corp may be better. However, you should always talk to your tax advisor and your attorney to figure out which is best for your particular circumstances and goals..

When An S Corporation Is Better

An S corporation works really well when you’re taking all the money out because there’s only one tax level—at the shareholder level. That means the owner is the only one that’s taxed—the company is not taxed. This is the best option if you’re going to take all the money out of the business. 

When A C Corporation Is Better

There are also many advantages to going the C corp route, including a 21% corporate tax rate. In a state like Texas or Wyoming or Nevada (where there aren’t corporate taxes), you’re getting a 21% flat rate on all the money you leave in the company. The more you can keep in a C corp, the better off you will be because of the 21% tax rate.

In a C Corp, the corporation is taxed, and then, when money is distributed, it’s taxed again at the shareholder level. If you’re taking money out of the company, it probably should be as salary, because otherwise, you’re going to be double taxed.

What’s Next?

After you decide how to tax your business (S Corporation or a C Corporation), you need to pay yourself a reasonable salary. You’re going to want a bookkeeper. 

You’re an independent contractor employed by your business now, but you’ll have to correctly handle the withholdings. This includes filing the payroll tax reports. An experienced lawyer can help you get through this process and make sure you set everything up properly. 

 

Interested in learning more? Check out our articles Using Your S Corp: Payroll Taxes and Using Your C Corporation’s Tax Brackets To Reduce Your Tax Burden.

What Is Corporate Compliance and Why It’s Important For Investors

If you go through the effort of forming, building, and growing a company, you want to be sure to do everything you can to protect your business. One thing you simply can’t afford to ignore as a business owner is compliance. Let’s talk a bit more about what corporate compliance means, involves, and looks like.

What is Corporate Compliance?

Broadly speaking, corporate compliance describes how closely your company adheres to the law and any other policies it should be following. You can break it down into two basic categories:

Internal and External Compliance: What You Actually Need to Worry About

And don’t worry, that headline’s not a tease. We’re seriously going to show you how to not give a single solitary F-bomb about compliance. 

Internal compliance matters because it allows you to control your “in-house” liabilities, such as setting up the proper type of company, asset protection, contractor and property manager issues, and much more about your day-to-day.

External compliance, on the other hand, is more focused on the legal pieces of your company needs. This is just one of several reasons why attorneys offer services to assist. Attorneys can help you satisfy the most critical pieces of external compliance, which in our opinion are:

Of course, pros are happy to give you tips too, but generally good ones don’t do it for free. Paid consultations give you a competent real estate support team. This is especially important for ...

Both concepts of compliance are vital and can be offerings of full-service corporate compliance firms or agencies. Let’s dive into why you might think about using one, and your alternatives if you’d rather not pay.

Why Your Company’s Compliance is Crucial

The consequences of noncompliance aren’t pretty. What consequences will depend on the severity and type of noncompliance, but none are pleasant. If your LLC is noncompliant because you got a LegalZoom or similar company’s weak cookie cutter LLC, it may be totally useless as a business entity and thus offering you no real lawsuit protection. With so much on the line, why play around? 

Corporate Compliance: The Real Estate Investor’s How-to Guide

While all of these rules and regulations may seem like a drag, fortunately, you don’t have to wade through all the legalese and paperwork on your own. Professionals can help you be certain of your company’s compliance, with many offering specific corporate compliance services. Let’s talk about what these services look like in real life.

Real Estate Compliance Options

Generally, here are the kinds of services you can purchase from full-service firms. The value of a full-service firm is greater for real estate investors who have more expensive time. “Expensive” by the way can be measured in numbers for most of us. Look at what you average as an hourly rate and decide if putting even one or two hours of time towards compliance is “worth it.” If you can’t get the job done for under $100-300, you absolutely want to think about full-service. Even if your hourly rate is $20, that gives you five hours a year to devote to compliance. The idea that compliance services are for “rich investors only” or those who are well on the way to success is BS, to be blunt. Here’s the quickest, but not only, reason why. 

You can pay a full-service legal firm (not an online LLC-in-a-box shop because lawyers are more effective than LegalZoom or template companies, always) very little money to have them address that list of obligations above. Moreover, investors who purchase a compliance package usually get these things:

How You Can Save Thousands in Taxes with an S-Corp

If you are an active real estate flipper or wholesaler, you are more than likely subject to the self-employment tax (15.3%). Read on to discover how you can save thousands on your tax bill by electing to be taxed as an S Corp.

A flipping or wholesaling business is not considered to be a passive activity like rental real estate. Instead, it is considered an active business. And because flipping and wholesaling are active businesses, you are subject to the full 15.3% self-employment tax which can lead up to an $18,130.50 $21,068.10 (updated for 2020) tax on your earnings, ouch!

You can definitely find a better use for that money, right?

How Can Being Taxed as an S-Corp Help?

Creating an S-Corp, or an LLC taxed as an S-Corp allows you to hire yourself as a W-2 employee and split your earnings between salary and distributions.

In this strategy, you only pay the 15.3% SE tax on the part of your income considered salary, and not on the distributions.

It is important to note that the wage or salary you pay yourself must be reasonable, otherwise the IRS might charge you back taxes and penalties (i.e. your wages can’t be $1 and dividends $99,999).

Example

You are a real estate flipper with earnings of $167,830 for the 2018 tax year. If you are simply a sole proprietor (or partner), then all of your flipping income is considered active, and up to $118,500 would be subject to the 15.3% SE tax – totaling $18,130.50.

However, if you set up an LLC and elect to be taxed as an S-Corp, you can split the earnings between salary and distributions. With the help of a CPA, you determine $65,000 to be a reasonable salary. This means you will only pay the SE tax on $65,000, saving $8,361.

Potential Pitfalls of this Tax Strategy

Of course, Uncle Sam wants his money, so it’s never that easy.

Service companies are more likely to be scrutinized by the IRS when using this strategy because most of their earnings come from personal efforts, and not from that of other employees. That is why it is imperative to work with a CPA to research and document the reasons behind the reasonable salary you decide to pay yourself.

Also, the IRS requires companies with W-2 employees to pay a Federal Unemployment Tax (FUTA) of 6.20% on the first $7,000 of income for each employee. In some states, you could also be subject to the State Unemployment Tax (SUTA). Once you implement this strategy, you will be considered a W-2 employee and will have to pay this tax.

There are also costs involved in creating the entity and filing a separate tax return if you’re not already a partnership. And for S Corps, there are some administrative requirements such as setting up a board of directors and holding meetings.

The Bottom Line with S-Corp Taxes

Creating an entity and having it taxed as an S Corp has its advantages and can potentially lower your tax liability, but may not be for everyone.

There are costs involved with setting up and maintaining the entity, which will have to be weighed against the actual tax savings you will receive. In many cases, this strategy will make sense for higher-income earners (people earning at least $50,000 from their business).

You will want to discuss the advantages and disadvantages of this strategy with your CPA to find out if this makes sense for you based on your personal circumstances. There are always unique circumstances, such as a husband-and-wife business (sole proprietor or partnership).

You may also be interested in our article, "How To Take Money Out Of Your S Corp."

About the author: Thomas Castelli, CPA is a Tax Strategist and real estate investor, who helps other real estate investors keep more of their hard-earned dollars in their pockets and out of the government's. You can find more articles from Thomas by visiting The Real Estate CPA’s website.

Keep more of your money with a Royal Tax Review

Find out about the tax savings strategies that you can implement as a real estate investor or entrepreneur by taking our Tax Discovery quiz. We'll use this information to prepare to have a productive conversation. At the end of the quiz, you'll have an opportunity to schedule your consultation.    TAKE THE TAX DISCOVERY QUIZ

Calculating the New Pass-Through Deduction for Real Estate Investors

The Pass-Through Deduction, introduced by the Tax Cuts & Jobs Act, allows sole proprietors, partnerships, and S-Corporations to deduct up to 20% of their qualified business income (QBI).

Since many real estate investors operate under one of these entities mentioned, how will this impact you?

Investors with Taxable Income Below $157,500 ($315,000 if married)

If you operate under one of the entities mentioned above, and have taxable income less than $157,500 ($315,000 if married), you will simply be able to deduct 20% of your qualified business income (QBI).

For small landlords that report rentals on Schedule E, this deduction will apply to the aggregate income or loss of your rental activity, and not to each individual property (at least as of this writing). Because rental real estate often creates a loss for tax purposes, this deduction may not apply to everyone.

However, flippers, developers, agents, and larger landlords should see a greater impact from the deduction.

Example: You are a married investor with five rentals that produce net operating income of $90,000. You also have W-2 wages of $160,000, because you are below the $315,000 threshold, you will be able to deduct $18,000 from your net operating income ($90,000 x 20%).

Assuming you are in the 24% tax bracket, you will save $3,600 on your tax bill.

However, if your five rentals produce a net operating loss of $13,700, you are not eligible for this deduction even if one of the five rentals produces net operating income.

Investors with Taxable Income Above $157,500 ($315,000 if married)

If you’re an investor with taxable income above these thresholds ($157,500/$315,000), things get a little more complicated as W-2 wage limitations have to be considered.

Below are the rules to calculate the pass-through deduction if your taxable income is above the phase-out thresholds:

Example: If your QBI is $350,000, your business has $120,000 in W-2 wages, and has qualified business property with an unadjusted basis of $1,200,000, your pass-through deduction will be the lesser of:

Your deduction in this example would be $60,000. Assuming you’re in the 35% tax bracket, you will save $21,000 on your tax bill. 

The Bottom Line on the Pass Through Deduction

The pass through deduction has the potential to shave thousands off your bill if you operate as a sole proprietor or use a pass-through entity such as a partnership. However, small landlords may not see the benefit if their aggregate rental portfolio shows a loss for tax purposes.

Because this deduction is still new and can be complicated to calculate, it is recommended that you work with your CPA to determine how this deduction will impact your specific situation.

Author: Thomas Castelli, CPA is a Tax Strategist and member of The Real Estate CPA, an accounting firm that helps real estate investors keep more of their hard earned dollars in their pockets, and out of the government’s, by using creative tax strategies and planning.

Series LLCs and S Corporations: Which Is Best For Your Business?

Limiting your liability is an important factor when you start a business. Because of this, many entrepreneurs start with a limited liability company (LLC) or an S corporation. But which one is right for you?

What Is The Difference Between A Will And A Trust?Similarities Between A Series LLC and an S Corporation

There are many similarities between an LLC and an S Corp.

Differences Between A Series LLC and an S Corporation

There are some significant differences between LLCs and S corporations.

 

What's a 'Pass Through Entity' & How Does It Help Real Estate Investors?

A pass-through entity is a business structure, such as an LLC, series LLC, or S corporation. We use the term "pass-through" because you can claim the income of these types of businesses on your personal income tax returns instead of a separate business tax return. Watch the video below and I'll explain:

LLCs Can Function as Pass-Through Entities

The LLC, or Series LLC, has the easiest tax returns for a single member. As a pass-through entity, all of the income from your company can be recorded on your personal income tax return.

That means you won't be taxed twice and or have to pay thousands of dollars to a CPA to file a business tax return. Normally other business structures have to file a business tax return.

Do you and your spouse file joint income tax returns? That's no problem, the above would still apply. But there are some instances where you will have to file a separate return, despite using a pass-through entity. We'll discuss this, and some of the other basics you should know about pass-through entities, below.

The Partnership Return for Multi-Member LLCs

Some states require at least two members in an LLC. Let's say, for example, you and your partner have an LLC. You're going to file what's known as a partnership return. A partnership return is a separate return for the business itself.

Due to the complexity of a partnership return, you're most likely going to want somebody to help you prepare it. I suggest you hire a CPA who is also a real estate investor.

Also note that an LLC is able to be taxed as a corporation. In some instances it can make sense in terms for your operating company to have that LLC taxed as an S corporation. So keep that in mind.

Speaking of real estate LLCs...

Which Pass-Through Entity Is Best For A Real Estate Investor?

The series LLC offers unbeatable asset protection, easy tax filing and is the foundation of a solid asset protection plan.

Say you own 5 properties. Instead of holding all 5 properties in one LLC, with a series LLC you can create a "series" within your LLC. Each series will hold one property.

The benefit of this is if someone sues one of your series and wins, only that one property in that one series will be affected. The majority of your wealth and assets would be protected.

Another great benefit is, no matter how many "series" you have within your LLC, they can all be filed on the same income tax return. This is a huge cost saving benefit you can't get with a regular LLC.