S corp savings vs sole Prop

[ptax255]

Hi, am I missing anything major with the calculations below? Sole prop looking to convert to S corp. Thanks!

	Sole Prop	S Corp
Net income	$111,835.00	$36,835.00
Wages	$0.00	$75,000.00
SE tax deduction	$7,850.00	$5,738.00
QBI Deduction	$7,375.00	$7,367.00
Solo 401K deduction	$43,151.00	$41,250.00
Income Tax	$18,710.65	$20,118.00
SS+Medicare	$15,699.00	$11,476.00
CA S corp tax	0	$2,177.53
Total tax	$34,409.65	$33,771.53	$638.12	Savings

[Strongsilence-CPA]

CA tax is 1.5% X net income. I don't know how you get $2,177. Maybe you are not showing CA adjustments from Federal.

QBI deduction looks right (if there is no capital gain income.)

[TaxGuyBill]

I haven't analyzed your numbers, but at first glance it looks reasonable.

Based on your numbers, I certainly hope he doesn't elect to be taxed as a S-corporation.  The costs to file the 1120-S, 941s, 940, W-2, pay unemployment, and reduced potential Social Security benefits would make the S-election seem like a bad idea.

[Strongsilence-CPA]

Payroll processing costs

Legal fees for incorporation

Costs for another tax return, annually

Your fees for guidance and CAS related to reasonable compensation, health insurance, accountable plans and other S Corp matters

[qbteachmt]

Agree with TGB, unless there already are employees (but you listed Solo 401(k)). Also, this affects office in home deduction, vehicle mileage allowance, meals and lodging provisions; there are some ">2% shareholder" limitations and ">10% shareholder" limitations. They already get a benefit from health care premiums (so that's a wash). If that income isn't a nice, regular, feed, then S Corp management really is difficult by comparison to SP.

[abctax55]

And the CA 1.5% is 'inclusive' of the $ 800.00 minimum tax, so it doesn't kick in until CA NI is more than $ 53,333.

[Strongsilence-CPA]

The PTE deduction is another factor and might be a significant benefit.

[ptax255]

Isn't $800 the minimum to be paid? Also if I'm not mistaken it's waived for first year? I'm also including as CA tax 1.1% SDI on wages.

[ptax255]

Agreed. I didn't inlcude it because for 2024 election, payment had to be made by June.

[ptax255]

Thank you! Fair point with home office deduction. As a sole prop it's about $22K, which wouldn't be reasonable as S corp.

[George4Tacks]

Also take into account how much liability insurance you can buy, without all the paperwork overhead, to get the protection you might be looking for as an S-Corp. 

[abctax55]

"...Also if I'm not mistaken it's waived for first year? "

Are you planning for just one year, or for multiple? 

And CA tax of $ 2177 would mean income of  $ 145,134 - which is way more than your projections show.

[ptax255]

Multiple years, but I'm also trying to determine if client should make a retroactive 2024 election, or start in 2025. By showing 2024 savings, I think 2025 and later would be greater due to PTE (pending any tax law changes of course). Additional CA tax for 2024 then would just be 1.1% SDI.

[TaxGuyBill]

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@ptax255 wrote:

I'm also trying to determine if client should make a retroactive 2024 election, or start in 2025.

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Why would the client want to do it AT ALL?    Based on your numbers, after the increased tax preparation/payroll fees and paying Unemployment, they likely will be paying MORE money.  Plus they will reduce their future potential Social Security benefits.

Even if it was a good idea (which at first glance it seems like a very bad idea):

• Is this already an LLC?  Did you already factor in the CA franchise tax for the LLC?
• What makes you think it qualifies for the late election?  You can't arbitrarily decide to make the election after the due date.

[qbteachmt]

"with home office deduction. As a sole prop it's about $22K"

Whew! cough-cough. I just choked on my coffee while reading this.

[ptax255]

Spoiler

That northern CA kind of mortgage, taxes etc

[qbteachmt]

Point being, doesn't $22K kind of settle the issue to that side?

[PATAX]

Based on what you have provided and on what the others have said, it doesn't look like there's much of an advantage to change. Don't forget that S corporations that do not pay what is deemed as reasonable compensation are prone to IRS audit, which could lead to a full audit. Audits are expensive and nerve-racking to the client, even if it is eventually  a no change audit. If the client wants limited liability, can you become a sole member LLC/disregarded entity?

[ptax255]

Wouldn't the amount be the same at $22k as S corp under an accountable plan?

[qbteachmt]

"under an accountable plan?"

Maybe. I found this for you:

https://accountants.intuit.com/articles/home-office-deductions-expenses/

[ptax255]

Updated based on everyone's feedback. Thanks! Curious, what amount do you all think it's worth all the extra work of an S corp?

	Sole Prop	S Corp
Net income	$111,835.00	$36,835.00
Wages	$0.00	$75,000.00
SE tax deduction	$7,850.00	$5,738.00
QBI Deduction	$7,375.00	$6,681.87
Solo 401K deduction	$43,151.00	$41,250.00
CA Tax deduction		$1,625.00
PTE		$3,425.66
Income Tax	$18,710.65	$18,590.07
SS+Medicare	$15,699.00	$11,476.00
CA S corp tax	0	$1,625.00
Total tax	$34,409.65	$31,691.07	$2,718.58	Savings

[Strongsilence-CPA]

I don't have an opinion on the amount that makes it worth it.

I advise running several scenarios of nontaxable distributions vs. wages then analyzing those outcomes before making a decision.  Maybe consider 2024 and 2025 if possible.

And, as someone noted earlier, there are impacts on Social Security for different wage amounts. 

It's complicated right, but I think the timing principle is a big consideration:  Does the client save taxes now (and take advantage of that savings with investing it prudently) in order to defer taxes much later?

[Strongsilence-CPA]

22K of home expenses deducted!  How is an S Corp accountable plan able to deduct 22K but a Sole Proprietorship can't deduct 22K?  

[qbteachmt]

"How is an S Corp accountable plan able to deduct 22K but a Sole Proprietorship can't deduct 22K?"

It's the other way around. As an employee, there are no home office deductions any longer. There would need to be some authentication for that high of a reimbursable expense under an accountable plan, and the activity alone might not even qualify. Example: a sports referee doesn't work at home.

[TaxGuyBill]

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@ptax255 wrote:

Updated based on everyone's feedback. Thanks! Curious, what amount do you all think it's worth all the extra work of an S corp?

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That is something the client needs to decide.  Things to inform the client:

• Tax saved.

Versus

• Extra cost of income tax preparation.
• Extra time/cost for bookkeeping.
• Extra cost of payroll processing, payroll returns, year-end payroll stuff, etc.
• Extra cost of unemployment.
• Amount of reduced potential Social Security benefits.  In my opinion, if a tax preparer does not discuss this with the client they should NOT be recommending an S-corporation because the client would usually be mislead by only telling them of the tax savings (and potentially set up the tax preparer for a lawsuit for under-informing the client).