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S corp in California - Worth it?

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  • S corp in California - Worth it?

    Hello,

    Current medical resident who will be graduating this year. In the course of asking a lawyer to review an employment contract, he brought up that I should form an S corp for the liability protection and tax benefits. Unfortunately, I am a California resident, and from the research I have been doing the tax benefits seem pretty weak. Here is a breakdown of the calculations I have been doing:

    Gross income: $400,000
    Medicare tax: $11,600 (2.9%)
    Social security: $14,694 (12.4% of first $118,500)
    Obamacare: $1,350 (0.9% of every dollar after $250,000)

    Total: $27,644

    Comparing this with an S corp, and assuming I pay myself $200,000 as salary and $200,000 as a distribution:

    Medicare: $5,800 (2.9% of $200,000)
    Social security: $14,694 (12.4% of first $118,500)
    Obamacare: $0
    California Franchise Tax Board: $6,000 (1.5% of $400,000, the total income of the S corp)

    Total: $26,494

    Total savings: $1,150

    The real kicker in this situation seems to be the California Franchise Tax Board tax, which takes away $6,000 of the benefit of the S corp and leaves only $1,150 behind. To be honest, I don't think $1,150 is enough savings for the hassle, and will likely pay an accountant and lawyer more to set up and maintain the S corp than benefit I will get.

    However, there is also the consideration of the liability benefit. I know as a physician I gain no protection from incorporating when it comes to malpractice, which is my single greatest liability. However, the lawyer was arguing that the S corp could provide additional personal liability protection in the unlikely event that the partnership has a large judgement against it. I find this to be very unlikely, and without a significant tax benefit in the state of California, I am hesitant to put a lot of time into maintaining an S corp. I have also read that the S corp provides very limited personal liability protection if the court decides to "pierce the corporate veil", which it is more likely to do if the corporation is not deemed to be substantively different than the individual (in this case, me providing services as an independent contractor).

    This is my understanding of the S corp based on my discussion with others and internet reading. It seems that if the tax benefits and personal liability benefits are this weak, why would I bother to set one up? I hope some of you reading this are much more educated in the subject and can steer me in the right direction.

  • #2
    No its not worth it and if you dont have employees or anything there is no liability protection whatsoever, its all the same but costs more and has more hassle.

     

    I did the same thing fwiw, everyone says to do it for some reason reflexively, but if you read the books you get all the same deductions and the costs to do so in California are very high. Some states its worthwhile, just not here.

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    • #3
      You have laid out a pretty good case. Given that you have a good understanding of the risks involved and the limited (if any) protection available, a better option might be to have a hefty umbrella policy instead.
      Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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      • #4
        Thanks for the quick replies. For the type of risk I'm referring to (a catastrophic multi-million dollar settlement against the partnership), would an umbrella policy cover this type of loss?

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        • #5
          Probably not. I have a 5 million dollar umbrella and they are very specific about not extending any personal/professional liability. If the case was that wild, they would probably not have any problem piercing the veil if they felt it was so bad.

          For highly improbable things, its best to insure, otherwise you're just over paying. Im not sure what kind of case would be involved that could extend to the practice though and go over your personal liability limits. One of the benefits to being in California is that malpractice cases have a very high burden and are limited by tort reform to reasonable things, and of course economic damages. Still, seems exceedingly unlikely and dont think a little S corp would help whatsoever. All the other asset protection strategies are probably better, 401ks etc...

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          • #6
            On my phone so I'll be brief. California FTB corporate tax applies to net income not gross income. In your example gross income of $400,000 is reduced by your $200,000 salary. The net income of 200000 is then subject to the 1.5% CA FTB tax. Furthermore business-related expenses, such as CE courses, malpractice insurance, association dues for the reduce your net income.

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            • #7
              Also if you establish a solo 401k that will further reduce your net income reducing your ca FTB tax.

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              • #8




                Also if you establish a solo 401k that will further reduce your net income reducing your ca FTB tax.
                Click to expand...


                To do that his salary needs to be at least 260k, and it still doesnt make a lot of sense in a trade off sort of way. There arent any deductions he cant take as an SP, and the gain he gets is small compared to the cost and extra work, and in many cases wont break even. The more chance it can break even and the more likely someone will question the fact that the dividend is more than the salary and makes you kind of a target.

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                • #9
                  I agree with you that if OPs distributions exceed their W-2 income, it may raise red flags. Something that s/he needs to discuss with their advisors.

                  Also, there are additional expenses with an S Corp not incurred as a sole proprietorship. For example, payroll processing, additional employer taxes, and Federal & state S Corp tax returns.

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                  • #10
                    You can minimize FTB to minimum ($800/year) by taking some as your salary from S corp (which is a deduction and you're not paying FTB on it), some money keep in the S Corp for "future business use" and take rest as distribution. Also, you've to keep in mind S corp tax return cost and some bookkeeping expense.

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                    • #11




                      You can minimize FTB to minimum ($800/year) by taking some as your salary from S corp (which is a deduction and you’re not paying FTB on it), some money keep in the S Corp for “future business use” and take rest as distribution. Also, you’ve to keep in mind S corp tax return cost and some bookkeeping expenseAn
                      Click to expand...


                      An S Corp is considered a pass-through tax entity.  Net income, which is subject to FTB, is not reduced by a "future business use' account.

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