Issue link: https://www.massageandbodyworkdigital.com/i/1464088
L i s te n to T h e A B M P Po d c a s t a t a b m p.co m /p o d c a s t s o r w h e reve r yo u a cce s s yo u r favo r i te p o d c a s t s 79 Filing as an S corporation can mean saving a significant amount in self- employment taxes (Social Security and Medicare). Massage therapists filing as a sole proprietorship or LLC (identical tax status) pay self-employment taxes on all income. So if your net income (business profit) is $60,000, you will be taxed 14.13 percent in Social Security and Medicare taxes on that income, or $8,478. However, when filing as an S corporation, you pay yourself in two ways. While sole proprietorship and LLC owners are paid only through distributions or owner's draw (moving money from your business account to your personal account), S corporation owners take compensation as payroll and distributions. Payroll is typically done through a payroll provider (there are some great high-tech options for solo business owners). This payroll is still subject to Social Security and Medicare taxes. However, the key point here is that you don't have to take all your compensation as payroll. As long as you pay yourself a "reasonable salary" you can pay yourself the rest as distributions. And in an S corporation, the remaining business income (which you can take distributions from) is not subject to Social Security and Medicare taxes. So going back to the example above in which the massage therapist made $60,000, let's say $40,000 of that is taken as payroll. The Social Security and Medicare tax of 14.13 percent would be applied to $40,000 this time, coming to $5,652. That's a savings of $2,826. In both examples, the massage therapist can "take home" the same amount. But in an S corporation, the business income is split between payroll and distributions from income. So should you be filing as an S corporation? The short answer is talk to your tax preparer. There are also variations in some state tax codes that may make it more or less beneficial to reconsider how you file taxes. Generally, the higher your net income is (your business profits) the more tax savings you can get from filing as an S corporation. TAXES AS A PASS-THROUGH ENTITY One thing that is important to be aware of is how these business entities are taxed, or rather not taxed, when it comes to federal and state income taxes. In every entity and tax filing status we've discussed (sole proprietorship, LLC, S corporation), the business itself is not taxed. All income "passes through" to your personal tax return. This is why these business types are often called "pass- through entities." In a sole proprietorship or single- member LLC, your business income is reported on your Schedule C. If you are filing as an S corporation, it will be reported on your Schedule E. In all cases, the business income attaches to your personal or joint tax return (the basic 1040) and becomes income you report. One side effect of this that some massage therapists may not be aware of is that you are taxed on the total business income reported, not just on what you take home. For example, let's continue our example and say you are an LLC and your net income for the year was $60,000. From that, you paid yourself $50,000 in distributions and left $10,000 in your business bank account. You are still taxed on the full $60,000. So, keep in mind that when it comes to federal and state income taxes, you are taxed on what shows up on your tax return—not necessarily what you paid yourself. CONVERTING FROM ONE BUSINESS TYPE TO ANOTHER Another detail to be aware of is how to convert from one type of business to another. There can be some work involved in making changes. One common scenario for many massage therapists is starting off as a sole proprietorship and then forming an LLC later in order to add a layer of liability protection. When this happens, a new EIN must generally be created, which also means most banks will require a new business account to be opened. This can cascade into a series of updates that must be paid with various service providers and can be a bit of a headache. Going from an LLC to filing as an S corporation is generally a little easier but it does require filing some paperwork with the IRS. Because of the complexity involved in going from a sole proprietorship to an LLC or S corporation, it may be advantageous to consider forming an LLC from the start if you are forming a new massage practice. LLC filing fees can be prohibitive depending on your state so weigh it against your financial situation, but bypassing a sole proprietorship and starting as an LLC from day one can help you avoid some headaches down the road if and when you convert to a new business type. WHICH ENTITY IS RIGHT FOR ME? If you're still not sure what business type makes sense for you, it never hurts to talk to your accountant, financial advisor, or attorney. They will be able to give you the most personalized advice that's right for you. But regardless, you are now armed with knowledge of the different types of businesses, how they work, and how they are taxed. Allissa Haines and Michael Reynolds are found at massagebusinessblueprint.com, a member-based community designed to help you attract more clients, make more money, and improve your quality of life. BLUEPRINT FOR SUCCESS