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Potential Tax and Other Financial Advantages of an LLC or S-Corp

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  • Potential Tax and Other Financial Advantages of an LLC or S-Corp

    I was listening to a much older podcast of the WCI and I'm paraphrasing but Jim Dahle had mentioned something about the potential benefits of having some kind of personal business, even if it's just filling out online medical surveys and your annual business income is only $10, so that you could then have access to a solo 401k. I'm assuming that would involve setting up an LLC. I'm looking for any additional advantageous tax moves I can make in the coming years as I don't necessarily plan on retiring near-term and in addition to the exposure that my and my wife's W2 income is getting to the higher tax brackets, I also have what is for me a forced sizable capital gains event happening before the end of this year just in time for those long-term rates to likely increase retroactively. I also have a potentially sizable capital gains event coming in the next few years as a private real estate fund I've been in for a couple years wraps up.

    I'm wondering if there are any good resources on further exploring what Jim had mentioned in terms of setting up a personal business as a possibility in the podcast? Or if anyone has some experience with doing this already and can share some guidance I would very much appreciate that as well.

    Thanks.
    Last edited by Cameron; 10-24-2021, 08:06 AM.

  • #2
    You don’t need an LLC or S corp. Once you have self employment income, you can just get an EIN and start a solo 401k.

    As for the sizable capital gains, you could see if your private RE fund allows for a 1031 exchange. Another option is to invest in an opportunity zone fund before the end of the year. I think 2021 is the last year to take advantage of the 10% increase in basis of any capital gains that you invest in opportunity zones. I know Passive Income MD has written about this.
    “Work” is a four letter word for good reason.

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    • #3
      I am sure there are comments I made in the very beginning of participating here back in Jan 2016 that I wouldn’t repeat today, but there is no way I have the time or inclination to go back and vet them all. Likewise, I would bet a cup of coffee that Jim might not word that same comment today, but he’s also probably too busy to go back and vet/rewrite some earlier columns. I may be 180 degrees wrong, though, and perhaps he’ll stop by.

      Lithium is correct about the need for S-Corp or LLC.
      • the only reason to set up an LLC is for liability protection.
      • the only reasons for a physician to set up an S-corp are for -
        • Liability protection if you have other employees and have a practice in CA and
        • To save on Medicare taxes (which must be factored against all related costs and complexity of operating as an S-corp and include paying a reasonable salary for profession and location).
      Otherwise, just go for sole prop.
      Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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      • #4
        Thank you very much for your input and insight Lithium andjfoxcpacfp. Yes, regarding the comments from Jim I was referencing, that might have been from the first WCI podcast - it was on managing student loans I believe and then he was addressing a few readers' questions. I understand that the perspective on this may have changed over such a long period of time and didn't want to present this as contemporary actionable information he had recently shared. Excellent to learn about the sole proprietership option and that would seem to be exactly what I would be interested in.

        As far as setting up a solo 401k then if one has a sole proprietorship, is the amount you can contribute to that account limited to how much business income that is earned? I was trying to research that and could see what the absolute maximum contribution limits were for a solo 401k, but so far have not found anything on whether you contributions are capped at your business income level. It would make sense that they were but just thought I would ask.

        Lithium, thank you so much on the Opportunity Zone fund recommendation. That had not occurred to me previously as an option for the capital gain I will be realizing this year. I do follow Passive Income MD so I'll go back and reference his articles/podcasts on it. I think I'll also reach out to Origin as I know that they have a QOZ fund for more information.

        I did previously check with the private real estate fund firm that I have a current investment with and the 1031 exchange is not an option. They told me that the entire fund would need to be set up that way and it is not. I'll have to deal with that sometime in the future. The forced capital gain this year is stemming from the sale of stock in a privately owned company that is being bought out by a larger firm with no option to continue with shareholder status with the new owners.

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        • #5
          Originally posted by Cameron View Post

          As far as setting up a solo 401k then if one has a sole proprietorship, is the amount you can contribute to that account limited to how much business income that is earned? I was trying to research that and could see what the absolute maximum contribution limits were for a solo 401k, but so far have not found anything on whether you contributions are capped at your business income level. It would make sense that they were but just thought I would ask.
          The profit-sharing contribution is calculated as 20% *(net profit - (1/2 related FICA taxes)). The absolute maximum contribution for 2021 is $58k.
          Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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          • #6
            Originally posted by Cameron View Post
            even if it's just filling out online medical surveys and your annual business income is only $10, so that you could then have access to a solo 401k
            I don't believe even WCI would now advocate that such a trivial scheme is remotely eligible to adopt a one-participant 401k.

            Having a Schedule C business profit is nowhere near sufficient in and of itself. You must also meet the requirements under 401c to be defined as a "self-employed individual" eligible to adopt a 401k. That definition requires you to have "earned income (net earnings from self-employment)" = business profit - 1/2 SE tax from a "trade or business" in the current or any prior year.

            In the final Qualified Business Income Deduction regulations (8/24/20), the IRS reiterated that the seminal SCOTUS "Higgins v. Commissioner" decision is the precedent for determining if a taxpayer is engaged in a trade or business. This decision held; the taxpayer is required to "enter into and carry on the activity with a good faith intention to make a profit or with the belief that a profit can be made from considerable, regular, and continuous activity.

            You do not have to take the last phrase literally. The SCOTUS decision states that it is a facts and circumstances determination. My personal opinion is that paying SE tax (profit >= $433) or receipt of a Form 1099-NEC (business income >= $600) with > $0 business profit are a minimum floor with other supporting facts and circumstances.

            Doing a small number of surveys with trivial income doesn't begin to cut it.

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            • #7
              Originally posted by Cameron View Post
              As far as setting up a solo 401k then if one has a sole proprietorship, is the amount you can contribute to that account limited to how much business income that is earned? I was trying to research that and could see what the absolute maximum contribution limits were for a solo 401k, but so far have not found anything on whether you contributions are capped at your business income level. It would make sense that they were but just thought I would ask.
              The tax code and IRS regulations are very clear. Maximum employee deferrals are the lessor of 100% of compensation or the employee deferral limit. Maximum self-employed employer contributions = 20% of self-employed earned income. Maximum (employee + employer) annual additions are 100% of compensation. Self-employed compensation = self-employed earned income - self-employed employer contributions.

              You will note there are potential circular relationships. That is why self-employed employer contributions are calculated as 20% of self-employed earned income and not 25% of compensation and employer contributions can be limited to self-(employed earned income - employee deferrals) / 2.

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              • #8
                Thank you very much for the extensive explanation of the actual regulations involved spiritrider. I see clearly this is not something to trifle with unless I actually did have a decent amount of business income. I can let this one go. Thanks again.

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                • #9
                  Originally posted by spiritrider View Post
                  I don't believe even WCI would now advocate that such a trivial scheme is remotely eligible to adopt a one-participant 401k.

                  Having a Schedule C business profit is nowhere near sufficient in and of itself. You must also meet the requirements under 401c to be defined as a "self-employed individual" eligible to adopt a 401k. That definition requires you to have "earned income (net earnings from self-employment)" = business profit - 1/2 SE tax from a "trade or business" in the current or any prior year.

                  In the final Qualified Business Income Deduction regulations (8/24/20), the IRS reiterated that the seminal SCOTUS "Higgins v. Commissioner" decision is the precedent for determining if a taxpayer is engaged in a trade or business. This decision held; the taxpayer is required to "enter into and carry on the activity with a good faith intention to make a profit or with the belief that a profit can be made from considerable, regular, and continuous activity.

                  You do not have to take the last phrase literally. The SCOTUS decision states that it is a facts and circumstances determination. My personal opinion is that paying SE tax (profit >= $433) or receipt of a Form 1099-NEC (business income >= $600) with > $0 business profit are a minimum floor with other supporting facts and circumstances.

                  Doing a small number of surveys with trivial income doesn't begin to cut it.
                  I never knew where you drew the line, probably some of our (minimal) disagreement over the years. Some of us make a lot with surveys!

                  Always love these discussions.

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                  • #10
                    That's the beauty of tax issues, in the vast majority of cases there is no line to be drawn. One could certainly make the case that a $10 survey roughly every other week is in fact and circumstances engaging in a trade or business. Making < $100/year with a small number of surveys, not such much.

                    Making enough to pay SE taxes and/or receive a 1099 and have a business profit at least you have a plausible trade or business. Also, no matter how small your self-employed earned income is, At least make an employer contribution. It helps establish the fact that it is a bonafide retirement account and not just a vehicle for accepting IRA rollovers.

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