What Are the Tax Advantages of Having a Business vs. Running an Operation as an Individual? | Attorney Aaron Hall

What Are the Tax Advantages of Having a Business vs. Running an Operation as an Individual?

In this video, you get answers to these questions:

  • What are the tax advantages of having a business vs. running an operation as an individual?
  • Do you want to set up a business or company, or should you operate out of my own name?
  • What are the tax advantages and disadvantages?
  • What do you pay income tax on?
  • How can an LLC be taxed
  • How is a single owner taxed?
  • What happens when you have an S. Corp?

 Video Transcript

What are the tax advantages of having a business versus running an operation as an individual? My name is Aaron Hall. You can learn more about me at aaronhall.com, and please see the disclaimer below this video. Imagine you are starting a business. You’re an entrepreneur and you’re trying to decide, do I want to set up a business or company, or should I just operate out of my own name? What are the tax advantages and disadvantages associated with that? Well, first it’s important to remember that if you operate under your own name, you are what’s called a sole proprietor. In other words, you have a business, you’re a business owner, you have a proprietorship. You’re a single person running a business under your own name. You don’t have a separate legal entity like an LLC partnership or corporation. You’re just running under your own name as a sole proprietor. You are still permitted to deduct from your taxes all expenses associated with the business.

So compare that to being an LLC. If you have an LLC, you can deduct your business expenses and you only pay income tax on the profit that you have left over at the end of the year. In the very same way in a sole proprietorship, that is how you will pay taxes. In other words, you’ll add up all of your income from the business, you’ll deduct your business expenses, and then you only pay income tax on the profits left at the end of the year. The expenses of the business are recorded in schedule C of the tax return here in the United States. So there really is no difference between a sole proprietor running a business under their own name and a person who uses an entity, unless you’re using an S corporation or a C corporation.

Now let me pause for a second. An LLC can elect to be taxed in any of these categories. So you could have an LLC that elects to be taxed as an S corporation or a C corporation. But the default is if you’re a single owner, an LLC is taxed as a sole proprietor. And if you have two people or more in a LLC, the LLC is taxed by default as a partnership. But what happens when you have an S Corp? The S Corp is a very popular option among small business owners because of an additional tax advantage available to you. Here’s how it works. When you pay… Let’s use an example. Let’s say you work at McDonald’s as an employee. You get your paycheck, and from that paycheck about 15%, you’ll see in your stub, about 15% goes to payroll tax. Half of that, about seven and a half percent is paid by you as the employee. The other half, about seven and a half percent is paid by the employer. But in all, that’s called a payroll tax, it’s about 15 cents for every dollar that’s earned.

Now, let’s think about if you’re running the business yourself. You’re still going to have to pay that 15% because now you are the owner, the employer, and you are the employee. So 15% is coming out towards that tax. In that environment it’s often called a self employment tax, but it’s still 15% so whether it’s called self employment tax or payroll tax, it’s about the same. Not only are you as a business owner paying payroll tax of about 15% you’re also then going to pay income tax on the profits at the end of the year, which are deemed now income to you. An S Corp has this special exception where payroll tax is kept or it’s limited.

Let me use a hypothetical. Let’s say that you have a S corporation and at the end of the year it has $100,000 left over after paying all expenses, except you. Now, if you are fulfilling the role of an employee earning $50,000 per year, you’ll have to pay 15% payroll tax on the wages that would go to you as an employee. But the remaining $50,000 is free of that a 15% payroll tax. Let’s just do the math real quick. 15% of $50,000 is $7,500 saved every single year on your taxes. Feel free to rewind this video if you missed that, I realize I covered it quickly. But the bottom line is that in the right circumstances, an S corporation can save you a significant amount of money on payroll tax. That’s when the S corporation is making enough money to pay you wages at a fair market value and then there’s leftover profits that get paid out to you free of the payroll tax.

Now you might be thinking, “Can’t I just pay myself a dollar and then almost all the money is free of payroll tax?” No, you can’t do that. The IRS says you have to pay yourself a fair market wage. So that typically means what could you hire somebody at in order to do the work that you’re doing? So is there a difference between using a business entity and operating under your own name as a sole proprietor? Yes, if you’re doing an S corporation, but from a tax perspective, there’s no difference. There is one other consideration which we’re not getting into here and that is limited liability. In an LLC, you have some limited liability, but that’s a topic for another video. To learn more, check out the other videos here or visit aaronhall.com.

Next Steps

To learn more, check out the other videos here or visit aaronhall.com.