Apple, Google & Amazon use the tax code to sharply reduce taxes. These same laws apply to anyone, you just need the education. In this episode, Tom explains how businesses of any size, and even employees, can reduce taxes like the big guys.
02:20 – Why Do Employees Need To Become Businesses?
04:55 – How Do Employees Organize As A Business?
08:26 – How Do You Setup An Entity?
09:48 – What’s The Difference Between An S Corporation & A C Corporation?
13:18: Why Must You Pay Yourself A Reasonable Salary?
16:54: How Do You Behave Like The Big Guys?
17:41: What Are The Tax Benefits When You Behave Like The Big Guys?
Announcer: This is The WealthAbility® Show with Tom Wheelwright, way more money, way less taxes.
Tom Wheelwright: Welcome to The WealthAbility® Show where we're always learning how to make way more money and pay way less taxes. Hi, this is Tom Wheelwright your host, founder and CEO of WealthAbility®. What if you could learn how to pay little or no tax like the big guys? Just because you're a small business or an employee doesn't mean you can't pay little or no tax like Google, Amazon, and Apple. You can still become tax-free wealthy as we like to say at WealthAbility®. Here's the thing, the tax benefits that allow Google, Apple, Amazon, Tesla, Uber, et cetera, to not pay any taxes by law have to be made available to all businesses. Now, as an employee, you're actually in a business. I mean you're doing, you're rendering services in exchange for money. That's a business.
Now, it's not a business under the tax law because you're an employee, all right? So what the very first thing we have to do is we have to become a business. So the way you do that as an employee is you become an independent contractor for the company you're already working for, all right? So let me give you an example. So at WealthAbility®, we have a very fine group of client relationship managers and these are the people that allow, that really help people become clients of WealthAbility® and members of the WealthAbility® network. So they wanted to take advantage, these guys all want to advantage of the tax benefits available to business.
So I sat down with them and I said, “Look guys, here's what you do. Men, women, look people, to be gender neutral, this is what we do. What we do is is we set you up as an independent contractor of WealthAbility®,” and then I'm going to show you over the next few minutes the steps that I explained to them to take in order to take advantage of all the tax benefits that a business gets under the tax law legitimately. They're there for everybody. I mean, and it doesn't matter. It can be General Motors, it can be Uber, it can be WealthAbility®. It can be my CPA firm], it doesn't matter, okay? All businesses get the same tax benefits. That's the law, okay.
So what I'm going to walk you through is how to first become a business and second, how to set up your business so that you're going to be able to take advantage of all of these great tax benefits because the tax benefits in business, it is the number one tax opportunity in the world is being in business. It does not matter whether you're in the US or Canada or Mexico or Singapore or Hong Kong or Australia, it doesn't matter, the tax benefits per business are roughly the same in every country. I've been to, I've spoken in like 15 or 20 countries and every time I look at the tax laws, and guess what, the tax benefits for business are consistent throughout the world. So whether you're listening to this in the in Texas or Alabama or New York, or you're listening to it in London or Paris or Sydney, you're going to be able to apply these same rules, okay?
So the first rule is you have to be a business. Now, let's say that you're an employee. So what do you do? Well start out by saying to your employer, “Would it be okay if I became an independent contractor?” In other words, instead of having an employee / employor relationship, could we have an independent contractor relationship? Now the employer, your employer is going to be a little dubious about this because they don't want to get caught with employment taxes. So the very first thing we're going to do after you … What you're going to tell them is, “Okay, look, I'm going to set up a company and my company will employ me. You then will have a contract with my company. Would that work for you?”
See, what the IRS wants is they want everybody to be on employee somewhere. So they either want you to be an employee of somebody else's business or employee of your business and as long as you are an employee of a business, they're happy, okay? They're comfortable. Employment taxes are being paid, you've got an employee employer relationship. The IRS really likes that relationship being there. So the very first thing you have to do is say, “Okay, Mr. Employer, I'm going to set up a business so that I'm going to be an employee of that business so you don't have to worry about me coming after you because you're going to put in our agreement that I can't anyway, okay, and I'm going to sign that and you're going to hire my company to do the work that I do.” Now we can even be specific. Can you say, well, you're going to hire my company and I'm the one who has to do the work. That's okay too, all right? But that's the very first thing we have to do.
Now, granted, not all employers will do this, so you have to choose, right? I mean, but a lot of employers, an amazing number of employers are willing to do this. It actually reduces their tax liability, right? Because think about it, they're paying half of your social security taxes, which by the way, I'm going to get in just a minute. I'll explain how you won't then double your social security tax because I don't want you to be penalized either. So they're paying. So if you're making $100,000 a year, they're paying about $7,500 of social security taxes every year, which if you weren't … If you were an independent country, they wouldn't have to pay. Now the temptation would be to say, “Well, then they should be paying me $107,500,” and you may be able to work that out with your employer. They may just be happy to have you as a contractor.
On the other hand, you may have to give back some of that or all of that $7,500 in exchange for them allowing you to be an independent contractor. Now the one issue you do have to deal with is health insurance. So you're going to sit down with your tax advisor and you're going to ask them, “How do I deal with my health insurance?” I'm just bringing up the practical issues here because I don't want to go through any kind of tax planning A, that I haven't done, don't do with my clients, and B, that causes other problems, okay? Health insurance is the big one, right? So we have to figure out how do we still get health insurance, okay, and maybe even how do we get health insurance with the current employer, which by the way, that's possible, okay? Sit down with your tax advisor and go through this and sit down with your … Maybe sitting down with your tax advisor and your HR rep, all right, in your current job.
So we need to become a business. I want to be clear. We need to become a business. Once you're a business, now the second step is equally as important as becoming a business. The second step is you must set up an entity. An entity is like a limited liability company or a corporation that allows you to operate as a legal person, okay? A person separate from you. Because what you're going to do is that entity is going to pay you a salary. So step number one, become a business. If you're already a small business, great. You've gone through step number one, but you still need to go through steps two, three, four, and five, and a lot of small businesses, this is the issue I find is that you are not doing steps two, three, four and five.
You have this great opportunity. You're already in business and yet you're giving up 90% of your tax benefits because your tax advisor doesn't tell you to set up an entity. That's step number two, set up an entity. Okay, so you talk to your tax advisor by the way and your attorney and you figure out, should this be a limited liability company or a corporation? Third, you have to elect how to tax that entity. You must make an election. There's a IRS form that you use to make an election. Sit down with your tax advisor, go and make sure that they fill out that form and file that form on your behalf.
Now, I would suggest you're going to want to be either an S corporation or a C corporation. You're saying, “But wait a minute. I thought you just said I was going to be a limited liability company.” You may very well be a limited liability company for state law purposes. In the tax law, there's no such thing as the limited liability company. You must elect how to be taxed, and if you don't, you're going to be taxed as a sole proprietor, which takes away half of your tax benefits. So make sure you sit down with your tax advisor and elect to be taxed as an S corporation or a C corporation. Now, why would you choose one over the other? An S corporation works really well when you're taking all the money out because there's only one level of tax and that level of tax is at the shareholder level. So that's the owner level. You're the only one that's tax. The company is not taxed.
So if you're going to take all the money out, if you're not going to leave it in and actually build your business with it, then I would suggest you ought to be an S corporation, okay? Now talk to your tax advisor. I'm giving you general broad guidelines as opposed to specific advice because I don't know your situation. Talk to your tax advisor and ask them, “Should I be an S corporation or a C corporation?” Now there are a lot of advantages these days to be in a C corporation including a 21% corporate tax rate. I mean, especially if you're in a state like Texas or Wyoming or Nevada where there's no corporate, where there aren't corporate taxes, then you're getting a 21% flat rate and on all the money you leave in the company. Now if you're taking money out of the company, probably should be through salary, okay, because otherwise you're going to be double taxed.
Remember in a C corporation, the corporation is taxed and then when money is distributed, it's taxed again at the shareholder level. So those of you who take all your money out of your company, you bleed your company dry and you want to be an S corporation. Those of you who are building a company like a technology company, you're building apps, you're doing, you're building a business. You may want to be a C corporation. I did another podcast on Section 1202 stock. You should go listen to the 1202 stock and C corporation podcast because there are some big opportunities if you're a C corporation. There's also medical expense deduction by the way that you get, that you can get in a C corporation if you're the only employee that there's some really good benefits there too. So sit down with your tax advisor on that one.
So S corp or C corporation, that's step number three. So step number one is you must become a business. Step number two is you have to form an entity, LLC or corporation. Step number three is you have to make an election of how to tax that entity and it should be either an S corporation or a C corporation. Now, this is assuming you're in business. This is not investment real estate. This is not investments, okay? I'm going to be clear, investments, we don't elect to be taxed as corporations. Please do not do that. That's a whole different discussion. If you're investing in rental real estate and that's your business, that's going to be different than what we're talking about here. We're talking about online businesses. We're talking about service businesses. We're talking about if you're an independent contractor, that's the type of business we're talking about here. So basically what you would normally think of as business as opposed to investing.
So step three, you're going to be an S Corp or a C Corp. Step four is you need to pay yourself a reasonable salary. So you need to do the withholding on it. You need to file the payroll tax reports. I strongly suggest, do not do this yourself. First of all, you're going to want a bookkeeper. You're in business now, so you want a bookkeeper. Even if you're an independent contractor for what used to be your employer, I would suggest you have a bookkeeper because now you have opportunities. By the way, you're an independent contractor. Guess what? You're allowed to go work for other people too. Now you may have some restrictions on working for competitors of your business, but there might be other opportunities to bring in more money.
So there's this idea that once you become a business, your whole thought process shifts, and while you may not do the same type of work for somebody else, now you got a business. You could go put other businesses, you could start other businesses, you could put them all in the same entity, okay, if you wanted to, right? Or you set up multiple entities. Again, sit down with your tax advisor. You do not do this by yourself, but most important is you have a bookkeeper and you have somebody handling your payroll. Now, maybe your bookkeeper. I've found that many bookkeepers do not know how to handle payroll properly. So what I tend to recommend is a payroll company, okay? There are several of them out there. I'm not going to name them because I don't necessarily want to promote the independent payroll companies, but they're not that expensive, okay?
So ask tax advisor, “Okay, I need a payroll company. Who should I use?” Make sure you set up a reasonable payroll. Now, what's reasonable? What's reasonable is what would you pay somebody else to do your job? Now, if you're an independent contractor, you're going, “Well, I'm getting paid X number of dollars, so therefore I should just take salary of that.” No, don't do that. Don't take a salary of more than half of the money that you're bringing in, okay? You don't need to take salary more than half. Even if you're a doctor, even if you're a consultant, the IRS, and this is by the way, just general information, right, but my experience with the IRS is, is that if you take a 50% salary, 50% of your, of the money you take out is in salary, and the other 50% is distributions then you should be okay.
Now, why do you want to do that? Because the salary is subject to social security taxes, but the distributions in an S corporation are not. Now if you're going to be a C corporation, all the money you take out in needs to be salary because otherwise you're going to pay tax twice, okay? So in a C corporation, you're probably going to take it all out of salary, in an S corporation, you're going to take half of it out of salary, not more than half of it, maybe less, but not more than half. That way, you're not at a disadvantage from a social security standpoint, vis-a-vis what you were as an employee, okay? If you're already in business, if you're, you're not an independent contractor with your former employer, then what you can do is just find out what's a reasonable salary for what you do. Again, not more than half of the money that you take out of the company and the rest of the money you're going to take out as a distribution on a quarterly basis.
Now, if you need it more often than that, set up a loan between yourself and the company, borrow the money as you need it, and then on a quarterly basis, have your bookkeeper make a journal entry to record it as a distribution, okay? Because again, it's very important that we behave like the big guys. If we're going to get the tax benefits of the big guys, we have to behave like the big guys, all right? So that word behave is critical here. Everything we do is we're going to dot our I's and cross our T's. We're going to have a contract with our former employer. We're going to have payroll set up properly. We're going to have books for our business set up properly. We're going to do all, everything the right way. We're going to file a tax return for our business. We're going to do everything the right way.
Now, does this complicate your life? Yeah, it does. It gives you more opportunities for more income and more opportunities for more tax benefits. Now let's get to the tax benefits because outside of the social security tax benefits, which are phenomenal, right? Because you just cut your social security tax in half. What about all the deductions? Remember in the 2017 Tax Act in the US anyway, employees no longer get employee business expenses as a deduction. They're no longer available to you. They used to be available subject to the 2% rule on your schedule A. They're not there anymore and they're eliminated permanently. This isn't a temporary loss of deduction. This is forever. So if you're an employee and you do things like you have meals, let's say you take a coworker out to lunch, not deductible.
Let's say that you have travel that's not reimbursed, not deductible. Let's say you have a home office, not deductible. Let's say that you move, not deductible, okay? None of these things are deductible. Let's say you go get some continuing education that's not reimbursed by your employer, not deductible. So all of these things that are not deductible, all of a sudden when you become a business are now deductible. Now what do you have to do to make an expense deductible? Four things you have to do. We've gone through this on another podcast in great detail on deductions, but let me give you briefly the four things you have to do. First of all, must have a business purpose, okay? Must be related to your business. If it's not related to your business, game over.
Number two, it must be ordinary, which means it's typical in your business, all right? So continuing education. Is that typical in your business? A home office, is that typically in your business? A car, is that typical in your business? What's typical in your business? Third thing is it must be necessary, meaning that the purpose of the expenditure is to make you a profit. Now, frankly, if you don't, if you're not going to make yourself a profit with that expenditure, you have to ask yourself, “Why am I making this expenditure?” Now if I'm spending the money because it makes me happy, great. Be happy. If we start thinking though, remember, the whole idea here is that we're starting to think like the big guys because we want to make money like the big guys and we want to pay taxes like the big guys. So we have to start behaving like the big guys. So what we're going to do is is we're going to actually spend money on things that will be profitable to us. Not some harebrained idea, but something that actually is going to be profitable to us.
Now that's three things. The fourth one is we're going to document it. If you're in a big company, now think about it, remember back when you were an employee and you had an expense that you wanted reimbursed, you had to give them a receipt. Well, now you're your own business. You must produce that receipt to your employer, okay, and get reimbursed. Your employer being your company or have the company needs to pay for it and keep the receipt. But that documentation is critical. If it's not documented, it's not a deduction. If it's not documented, it's not a deduction. That is rule number one. When you get, if you ever get audited, the first thing that the auditor is going to ask for is documentation of your deductions and they want receipts, by the way, not a credit card statement, receipts.
So make sure that you meet those four tests and then anything could be deductible. Your home office, your car, your travel, your education, your meals, all sorts of things become deductible as long as they meet the four tests and you have a business. If you're an employee, you don't get it. Even if it's business related, you do not get that deduction. So start a business and if that's business means that it's a business you've always wanted to do, great. If it means you're going to become an independent contractor with your … Of the company that is now your current employer, great too. Start a business, set up an entity, elect to be taxed as an S corporation or C corporation, for most of you it's going to be an S corporation. Pay yourself a reasonable salary and then start taking deductions that are ordinary necessary business deductions that you've documented.
When you do all this, what happens is is that you end up starting to make more money because when you start thinking like a business, you're start thinking for opportunities to making money. You're no longer restricted to that one customer, your employer. You're no longer restricted there. Now you get to look at what are all my business opportunities and so one of the purposes of the tax law is to encourage people toward business and expanding business and serving more people. When we do that, we make more money. When we spend things on business expenses, when we spend money in business expenses that are intended to make more money and they make more money for us, what happens? Our income grows. Now our income grows, but our taxes are actually going down because instead of paying for those expenses after tax, we're paying with them before tax.
Then when we have extra money, what are we going to do? We're going to create a wealth strategy to go invest in real estate, oil and gas, other active investments that can also bring us tax benefits, okay? Altogether this is called a wealth and a tax strategy. You want to know more about wealth and tax strategies, then call WealthAbility®. We're happy to help you find somebody. We have a whole network of tax advisors and wealth strategists that can help, that actually can help you do that. So we're happy to do that. It's wealthability.com. Go to wealthability.com and schedule an appointment. We're happy to help any way we can. If we can't help, we will tell you that too. So just remember that the purpose of the tax law, it's to incentivize certain activities and one of the biggest activities, in fact, the biggest activity the tax law wants to incentivize is business. So start your business. Get going. Make more money and pay less taxes and do it now. See you next time.
Announcer: You've been listening to The WealthAbility® Show with Tom Wheelwright. Way more money, way less taxes. To learn more, go to wealthability.com.