7 ms·

This rule is the reason I did not file to make my LLC an S Corp. (If that's the right term.) A regular single-member LLC, such as mine, is treated as one entit

This rule is the reason I did not file to make my LLC an S Corp. (If that's the right term.) A regular single-member LLC, such as mine, is treated as one entity with its owner for tax purposes. The LLC's income is my income, and I just file a personal return for it. This can be bad because it puts you in a higher tax bracket. An S Corp is a way around that. You have the LLC "pay" you a "wage," and you pay personal taxes on that, while the LLC pays whatever corporations have to pay. But if your LLC does software, like mine, congratulations! You can only deduct 20% of that "wage." I've been developing my software for years, and I am not done yet. I don't have revenue. So if I went the S Corp route, I'd actually have to pay taxes on 0 revenue. But as a regular LLC, my own work (as the owner) does not count as anything taxable, so I'm safe. If you are going into freelance, perhaps as a consultant, keep this in mind. And do submit a comment. Also, beware of accountants that will try to get you to do something that is not in your best interests. I had one or two try to encourage me to file as an S Corp, even though they admitted this could be a problem.

chatmasta 3y ago
> So if I went the S Corp route, I'd actually have to pay taxes on 0 revenue You'd only pay taxes if your revenue were more than your deductible payroll expenses (which as you say, you estimate to be 20% of your salary, which in an s-corp must be a "reasonable salary" for work performed). There's no case where this law causes you pay tax on zero revenue. The problems require some revenue before they affect you, which might actually be another argument against it - you're disincentivized to create revenue from your early product if it's not going to be enough to cover your tax obligations.
- gavinhoward 3y ago
  Well, I would hope you are right, but that's not what the accountants were saying.
  - dboreham 3y ago
    This is what the parent means by "batshit crazy".
    - gavinhoward 3y ago
      What parent?
  - patmcc 3y ago
    No accountant is saying you'd have to pay at literally zero revenue, unless they're very badly misinformed. The absolute worst case scenario would be having to pay taxes as if your revenue was nearly all profit - as if you had no expenses (or very few). As always, you only pay taxes on 'net income' - revenue minus expenses - this whole mess comes about by tweaking how expenses are calculated.
    - gavinhoward 3y ago
      > The absolute worst case scenario would be having to pay taxes as if your revenue was nearly all profit - as if you had no expenses (or very few). And that will be the case for me next year, so yes, this matters to me.
      - patmcc 3y ago
        Sure, it's reasonable to worry about that. But it's still not the case that you'd need to pay taxes on 0 revenue.
    - s1artibartfast 3y ago
      I know several people who are being advised by accountants that they have to pay for startups with net zero profit. It is literally backbreaking for a friend who is self funding a team of engineers. The money to pay taxes literally doesnt exist. It was paid as salary. I told him to ignore the accountants and simply not pay. Let the IRS come after him
      - patmcc 3y ago
        Accounting (and taxes) does not match one-to-one with cash flow. It is very critical for any business to understand this. This bites many businesses, sometimes very badly. It's especially difficult when the rules change, as they have in this case with R&D/software expenses. But there's a very critical misunderstanding happening in a lot of comments here -the IRS taxes profit (net income), not revenue. Anyone with zero revenue is safe. Anyone with SOME revenue will potentially owe some taxes, and potentially in a very surprising (and unfair, I think) way. The basic example in the submission is quite correct. >>>I told him to ignore the accountants and simply not pay. Let the IRS come after him. This is a great way to end up both out of business AND in jail. It is not the smart play.
dboreham 3y ago
Ianaa (I do own an LLC, an S-corp and a C-corp doing software though), but this sounds fishy. Besides some details at the margin such as payroll taxes, tax treatment (how much tax $y is owed on revenue $x) should be roughly the same regardless of the legal entity type.
- gavinhoward 3y ago
  The accountant explained it this way: did money change "hands"? If money went from the LLC into a "wage," it changed "hands." The IRS wants in on that. If work went from the owner into an LLC, no money changed hands, and the IRS doesn't care. But the very fact that people do S Corps shows that there is different tax treatment though.
- SkyPuncher 3y ago
  Single member LLC should really be its own business type in most states. Lots of special rules apply to them and only them. The benefits of S and C corps don’t really come into play with single member LLC
rrrix1 3y ago
Awesome. Thank you for this post. I've recently been stuck on this very topic as I begin to explore both consulting and building commercial products. I'll be following you! For the short term (contracting) I'm simply working as a Sole Proprietor, but I don't really have much work or significant income yet.
- chatmasta 3y ago
  You don't need to decide whether to file as an S-Corp or LLC or C-Corp until tax time. Don't hesitate to open an LLC if you're worried about getting it wrong. It's worth opening an LLC immediately just so you can get a business bank account. You don't need to worry about the tax implications until you actually file them and have to decide which elections to make.
  - candiddevmike 3y ago
    That's not true... There is a brief window for switching your LLC to a different tax classification, typically at the beginning of the year. It does not change the previous year.
- gavinhoward 3y ago
  Good luck! If I may make one suggestion: even if you want to be a sole proprietor, look into getting an LLC. If you run into trouble with a client, a properly-done LLC can save your house or other large assets. With a sole proprietorship, all of your personal stuff can be on the hook too. It's essentially the same advice as keeping separate devices for work and for personal use.
  - sarchertech 3y ago
    That’s a common misconception that isn’t correct in practice. LLCs don’t protect you from your own personal negligence. Meaning that in the vast majority of lawsuits a single owner LLC isn’t going to do much. As a software developer you’re unlikely to be sued over anything that can’t be classified as personal negligence or malpractice. LLCs also generally aren’t useful for protecting you from creditors, because any lender will require you to give a personal guarantee. If you are really worried about protecting your assets, you can purchase liability insurance.
gamblor956 3y ago
The accountants are not lying to you; you are misunderstanding what they are saying. A single-member LLC and a single-member S-Corp are both essentially flow-through entities for a solo entrepreneur. However, they are ultimately taxed quite differently: with an S-Corp once you exceed the SSI threshold for the essentially mandatory portion of revenue you must repatriate to yourself as a salary, the remaining income can be repatriated as qualified dividend which is taxed at a significantly lower rate than directly passed-through income. With an LLC, it's all self-employment income subject to regular income taxation, meaning that in any realistic scenario, you're paying a higher effective tax rate with the solo LLC form. So if I went the S Corp route, I'd actually have to pay taxes on 0 revenue. This is false. The income tax on $0 revenue (meaning no revenue, not no profits) is the same: $0. (Note, however, that many states have "fees" assessed on business entities like S-Corps and LLCs, even single-member LLCs, and in such cases a minimum fee is owed regardless of revenue.) But as a regular LLC, my own work (as the owner) does not count as anything taxable, so I'm safe. This is also false. The work you provide to the entity as an owner is still an R&D expenditure. The difference is that with the S-Corp, the expenditure cost is clearly documented, while with the LLC you're pretending that the number is $0 and gambling on not getting audited. This only matters once you start generating revenue... Either way, not all of your salary would be subject to capitalization. If you have revenue, you clearly spent at least some time and work on marketing and business development, and expenses for those non-R&D activities are not capitalized. With the S-Corp, your salary offsets up to [your salary assigned to non-R&D tasks less 1/10 [see note] of your current-year salary assigned to R&D plus carried-over capitalization from R&D from prior years] in revenue each year, and after an appropriate amount of salary (generally the SSI contribution threshold for the year) the rest of that annual revenue can be repatriated to yourself as a dividend at lower tax rates. With the LLC form, since you aren't paying yourself a salary, you owe tax on 100% of the revenue arising from the software you develop without any deductions. TLDR: If you actually care about tax, S-Corps are almost always the better option for the solo entrepreneur, and they're still the better option here. NOTE: Capitalization is on a mid-year convention, so the first and last year you only capitalize 1/10th of the cost; and in the middle 4 years you capitalize 1/5th of the cost. So, for Y2, if you paid yourself $100 in salary both years, your total capitalization deduction would be $30: $10 capitalization for the Y2 salary and $20 for Y1 capitalization.
antasvara 3y ago
If you have zero revenue, how are you paying yourself a salary from the S Corp?
- gavinhoward 3y ago
  I don't have an S Corp.
  - zapcto 3y ago
    Such a complete misreading of your comment has to be deliberate
  - antasvara 3y ago
    My general question is: how are you paying yourself money from a business woth zero revenue? The type of business is irrelevant. And yes, I know you don't have an S Corp. I was wondering how you would pay yourself from such a corporation, considering you have zero revenue.
    - gavinhoward 3y ago
      I'm not paying myself yet, nor will I pay myself in the classical sense when I get revenue. When you have a single-member LLC, you take "distributions," which basically means you withdraw money from the company and put it into your personal account. It's technically a dividend.
      - antasvara 3y ago
        Distributions from what? If you're making zero revenue, how is there money in the account for the business? I'm having a tough time understanding how there's money going out of an LLC without money first going in the LLC.

chatmasta 3y ago

> So if I went the S Corp route, I'd actually have to pay taxes on 0 revenue You'd only pay taxes if your revenue were more than your deductible payroll expenses (which as you say, you estimate to be 20% of your salary, which in an s-corp must be a "reasonable salary" for work performed). There's no case where this law causes you pay tax on zero revenue. The problems require some revenue before they affect you, which might actually be another argument against it - you're disincentivized to create revenue from your early product if it's not going to be enough to cover your tax obligations.

gavinhoward 3y ago
Well, I would hope you are right, but that's not what the accountants were saying.
- dboreham 3y ago
  This is what the parent means by "batshit crazy".
  - gavinhoward 3y ago
    What parent?
- patmcc 3y ago
  No accountant is saying you'd have to pay at literally zero revenue, unless they're very badly misinformed. The absolute worst case scenario would be having to pay taxes as if your revenue was nearly all profit - as if you had no expenses (or very few). As always, you only pay taxes on 'net income' - revenue minus expenses - this whole mess comes about by tweaking how expenses are calculated.
  - gavinhoward 3y ago
    > The absolute worst case scenario would be having to pay taxes as if your revenue was nearly all profit - as if you had no expenses (or very few). And that will be the case for me next year, so yes, this matters to me.
    - patmcc 3y ago
      Sure, it's reasonable to worry about that. But it's still not the case that you'd need to pay taxes on 0 revenue.
  - s1artibartfast 3y ago
    I know several people who are being advised by accountants that they have to pay for startups with net zero profit. It is literally backbreaking for a friend who is self funding a team of engineers. The money to pay taxes literally doesnt exist. It was paid as salary. I told him to ignore the accountants and simply not pay. Let the IRS come after him
    - patmcc 3y ago
      Accounting (and taxes) does not match one-to-one with cash flow. It is very critical for any business to understand this. This bites many businesses, sometimes very badly. It's especially difficult when the rules change, as they have in this case with R&D/software expenses. But there's a very critical misunderstanding happening in a lot of comments here -the IRS taxes profit (net income), not revenue. Anyone with zero revenue is safe. Anyone with SOME revenue will potentially owe some taxes, and potentially in a very surprising (and unfair, I think) way. The basic example in the submission is quite correct. >>>I told him to ignore the accountants and simply not pay. Let the IRS come after him. This is a great way to end up both out of business AND in jail. It is not the smart play.

dboreham 3y ago

Ianaa (I do own an LLC, an S-corp and a C-corp doing software though), but this sounds fishy. Besides some details at the margin such as payroll taxes, tax treatment (how much tax $y is owed on revenue $x) should be roughly the same regardless of the legal entity type.

gavinhoward 3y ago
The accountant explained it this way: did money change "hands"? If money went from the LLC into a "wage," it changed "hands." The IRS wants in on that. If work went from the owner into an LLC, no money changed hands, and the IRS doesn't care. But the very fact that people do S Corps shows that there is different tax treatment though.
SkyPuncher 3y ago
Single member LLC should really be its own business type in most states. Lots of special rules apply to them and only them. The benefits of S and C corps don’t really come into play with single member LLC

rrrix1 3y ago

Awesome. Thank you for this post. I've recently been stuck on this very topic as I begin to explore both consulting and building commercial products. I'll be following you! For the short term (contracting) I'm simply working as a Sole Proprietor, but I don't really have much work or significant income yet.

chatmasta 3y ago
You don't need to decide whether to file as an S-Corp or LLC or C-Corp until tax time. Don't hesitate to open an LLC if you're worried about getting it wrong. It's worth opening an LLC immediately just so you can get a business bank account. You don't need to worry about the tax implications until you actually file them and have to decide which elections to make.
- candiddevmike 3y ago
  That's not true... There is a brief window for switching your LLC to a different tax classification, typically at the beginning of the year. It does not change the previous year.
gavinhoward 3y ago
Good luck! If I may make one suggestion: even if you want to be a sole proprietor, look into getting an LLC. If you run into trouble with a client, a properly-done LLC can save your house or other large assets. With a sole proprietorship, all of your personal stuff can be on the hook too. It's essentially the same advice as keeping separate devices for work and for personal use.
- sarchertech 3y ago
  That’s a common misconception that isn’t correct in practice. LLCs don’t protect you from your own personal negligence. Meaning that in the vast majority of lawsuits a single owner LLC isn’t going to do much. As a software developer you’re unlikely to be sued over anything that can’t be classified as personal negligence or malpractice. LLCs also generally aren’t useful for protecting you from creditors, because any lender will require you to give a personal guarantee. If you are really worried about protecting your assets, you can purchase liability insurance.

gamblor956 3y ago

The accountants are not lying to you; you are misunderstanding what they are saying. A single-member LLC and a single-member S-Corp are both essentially flow-through entities for a solo entrepreneur. However, they are ultimately taxed quite differently: with an S-Corp once you exceed the SSI threshold for the essentially mandatory portion of revenue you must repatriate to yourself as a salary, the remaining income can be repatriated as qualified dividend which is taxed at a significantly lower rate than directly passed-through income. With an LLC, it's all self-employment income subject to regular income taxation, meaning that in any realistic scenario, you're paying a higher effective tax rate with the solo LLC form. So if I went the S Corp route, I'd actually have to pay taxes on 0 revenue. This is false. The income tax on $0 revenue (meaning no revenue, not no profits) is the same: $0. (Note, however, that many states have "fees" assessed on business entities like S-Corps and LLCs, even single-member LLCs, and in such cases a minimum fee is owed regardless of revenue.) But as a regular LLC, my own work (as the owner) does not count as anything taxable, so I'm safe. This is also false. The work you provide to the entity as an owner is still an R&D expenditure. The difference is that with the S-Corp, the expenditure cost is clearly documented, while with the LLC you're pretending that the number is $0 and gambling on not getting audited. This only matters once you start generating revenue... Either way, not all of your salary would be subject to capitalization. If you have revenue, you clearly spent at least some time and work on marketing and business development, and expenses for those non-R&D activities are not capitalized. With the S-Corp, your salary offsets up to [your salary assigned to non-R&D tasks less 1/10 [see note] of your current-year salary assigned to R&D plus carried-over capitalization from R&D from prior years] in revenue each year, and after an appropriate amount of salary (generally the SSI contribution threshold for the year) the rest of that annual revenue can be repatriated to yourself as a dividend at lower tax rates. With the LLC form, since you aren't paying yourself a salary, you owe tax on 100% of the revenue arising from the software you develop without any deductions. TLDR: If you actually care about tax, S-Corps are almost always the better option for the solo entrepreneur, and they're still the better option here. NOTE: Capitalization is on a mid-year convention, so the first and last year you only capitalize 1/10th of the cost; and in the middle 4 years you capitalize 1/5th of the cost. So, for Y2, if you paid yourself $100 in salary both years, your total capitalization deduction would be $30: $10 capitalization for the Y2 salary and $20 for Y1 capitalization.

antasvara 3y ago

If you have zero revenue, how are you paying yourself a salary from the S Corp?

gavinhoward 3y ago
I don't have an S Corp.
- zapcto 3y ago
  Such a complete misreading of your comment has to be deliberate
- antasvara 3y ago
  My general question is: how are you paying yourself money from a business woth zero revenue? The type of business is irrelevant. And yes, I know you don't have an S Corp. I was wondering how you would pay yourself from such a corporation, considering you have zero revenue.
  - gavinhoward 3y ago
    I'm not paying myself yet, nor will I pay myself in the classical sense when I get revenue. When you have a single-member LLC, you take "distributions," which basically means you withdraw money from the company and put it into your personal account. It's technically a dividend.
    - antasvara 3y ago
      Distributions from what? If you're making zero revenue, how is there money in the account for the business? I'm having a tough time understanding how there's money going out of an LLC without money first going in the LLC.