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There's not a single mention of taxes in the article. I don't think that the average employee is aware that an entrepreneur/founder/self-employed person can sa

There's not a single mention of taxes in the article. I don't think that the average employee is aware that an entrepreneur/founder/self-employed person can save a lot of tax if they structure it right and are meticulous about it. A self-employed person earning $70K a year can be better off than an employee earning $100K.

jdreaver 12y ago
Can you expand upon that? I am always looking to reduce my taxes. I got killed with my 1099s this year.
- adwf 12y ago
  I can't speak for American tax law, but in the UK there are some common methods of small business owners reducing taxes on income: Small payroll income so that you fall within a low income tax bracket. Top up salary with dividends as they have a much lower rate of tax. If you have a live at home wife, make sure she's employed by the company in some form, eg. you can pay her the minimum wage for secretarial duties. Ideally falling within the tax-free lower bracket. Unlike regular employment, you can start claiming a lot of everyday things such as food/transport/home office electricity/internet/etc. as business expenses, thus meaning you can claim 20% VAT (sales taxes) back depending. Ultimately, there's also the final payout if you manage to sell the company. If it were classed as regular bonus income, you'd be taxed at 45%. Instead you get charged as capital gains at 18-28%. You can also get entrepeneur relief on the first £10m which means you only get charged 10% instead of 28%. NOTE: Some of these are loopholes like dividends and employing family. They tend to get cracked down on every now and again (I'm not even sure if they're valid now) But when you get down to it, there are a heck of a lot of potential savings over standard income tax (currently 40% on anything over £32k, 45% over £150k)
  - jhome 12y ago
    I would appreciate if someone could correct me on this as this is mostly from memory. I believe the using dividends for tax avoidance is either no longer effective or has been cracked down upon. You can also give less to the government on your VAT if your profit (or revenues, I can't remember which!) is below 150,000 GBP. Rates vary between 9% and 15%.
    - adwf 12y ago
      Yep, they crack down on stuff all the time. Still slightly worth it as far as I know. You pay standard 20% income tax on the first £32k (with first ~£10k tax-free), then 40% upto £150k, 45% over that. Whereas with dividends you pay 10% on the first £32k income (minus allowances), 32.5% on everything upto £150k, 37.5% over that. So it's still worth it, but not quite as much as it used to be before IR35.
      - majc2 12y ago
        Anyway, anyone going down this line really needs to speak to an accountant, yada yada yada. For consultants/freelancers/contractors - dividends can be fine, if you can mitigate your exposure to IR35 (typically a bigger issue for contractors). Groups such as the PCG can really help here, but really the key thing is ensuring that any contract can't be thought of as disguised employment (control, substitutability and mutuality of obligation being the keywords) - speak to a Lawyer or a specialist accountant for advice or other clued up contractors for advice. The tax position on dividends is also a bit more subtle than above; if your total personal income is less than the £32k (minus allowances), then you're going to get the dividend tax credit back so the div is tax free. Granted the company is paying corp tax at 20% on all profits; but also it gives you options to defer company income becoming personal income, building up the company's reserves. As I understand it, you can wind up the company and get entrepreneurs relief which is also a worthwhile target for consultancies.
- greenyoda 12y ago
  If you're legitimately self-employed (see second paragraph), you should be able to deduct all your business expenses - home office, hardware, software, phone, travel, advertising, legal fees, etc. - on your Schedule C. You can also set up a self-employment retirement plan (SEPP IRA) and contribute to it.[1] You'll need good records in case the IRS questions your expenses, and you'll need to keep your work life separate from your private life (e.g., your home office space must be used solely for work; if you use your car for both business and personal trips, you'll need to log your business mileage). I'm assuming your work is legitimate self-employment, i.e., the people who pay you do not control your hours, tell you how or where to do your job, etc. If that's not the case, the law probably considers you an employee rather than an independent contractor[2], and you should be paid as one (W-2) - and you could get in trouble if you try to deduct expenses that are only valid for an independent contractor. (I'm assuming you're self-employed, not incorporated.) [1] http://employment.laws.com/self-employment http://employment.laws.com/self-employment [2] http://blog.intuit.com/employees/1099-contractor-vs-w-2-employee-a-decision-guide http://blog.intuit.com/employees/1099-contractor-vs-w-2-empl...
- jakejake 12y ago
  (Sorry in advance for this long, rambling response) This applies to the US and forgive me if you have already done some of this. The first step is to get your corporation set up (use an online service or an accountant). It's a bit of paperwork but you can do it for around $400. Once you do that you can open a corporate bank account. At that point you bill your clients as a corporation and provide them with your corporate tax ID instead of your personal SS. The money goes into your business account. Then to pay yourself, the next step is to setup payroll (easiest way is to use an online service like quicken payroll) which will run you about $50/month but will handle all of your withholding and tax filing requirements. It's somewhat of a pain getting this all going but once you do, you are operating as a corporation. Corporations do not pay income tax as such - they do have some filing fee type of taxes, but basically the taxes you pay come out of your payroll. So you do not pay tax on income that your company earns until you withdraw it from the company account via payroll. However, you can spend directly from the corporate account on anything that is reasonably considered a business expense. Computers and equipment, of course, can be purchased. Your company can pay the phone bills, internet connection, travel expenses, business lunches, etc. You can also charge your company rent as well if you are working out of your home. What happens is that you wind up paying yourself a meager salary on which you pay normal tax just like everybody else. So for instance, your company earns $80. You pay yourself a salary of $15k and the remaining $65k money is spent on operating expenses and is a tax write-off. You only pay tax on that $15k. You're likely to even get a small tax refund check instead of a huge bill from the IRS. In some extreme cases you might pay yourself even less, or even come in at a loss and pay no income tax. There is nothing illegal about this as long as your write-offs can be legitimately considered a business expense. This is also great because with payroll setup you are in a position to pay employees and sub-contractors via payroll as well and eventually grow your company with the proper financial system in place. I would highly recommend having an accountant set this up for you and file your taxes though because it is a ton of work and requires understanding the ever-changing tax laws.
  - hluska 12y ago
    > Corporations do not pay income tax as such - they do have some filing fee type of taxes, but basically the taxes you pay come out of your payroll. Are you sure that is correct? I am neither an accountant, nor even American, but IRS.gov says: "The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation." (source - http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Corporations http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employ...) For the 2011 tax year, Wikipedia pegs the US federal income tax rate at between 15% and 35% (depending on income level). (source - http://en.wikipedia.org/wiki/Corporate_tax_in_the_United_States http://en.wikipedia.org/wiki/Corporate_tax_in_the_United_Sta...) I think that only applies to C corporations, though I'm curious now about US tax law. Do tax shelters like you propose exist? Do you have any more information??
nicksergeant 12y ago
I would also like to see some examples. If you're just writing code all day, you have an awfully low overhead. I lose over half of my side income after I hit a certain point that's covered by my deductions, at which point I simply stop doing side work.
- mattdanger 12y ago
  In the US if you have a mortgage and/or office in your house you can take additional deductions. Contributions to an individual 401k are deductible.
  - nicksergeant 12y ago
    Certainly. And I do that. But after a point, you're losing a ton of money by not having enough deductions to cover your income.
    - dwd 12y ago
      Which puts you in the same position as an employee paying top tax rates. It's the pre-tax deductions (cost of doing business expenses) that differentiate working for yourself or for someone else.
      - nicksergeant 12y ago
        But those pre-tax deductions are pretty limited in the software development field. More code written != more deductions taken.
gr2020 12y ago
Can you elaborate on this?
croggle 12y ago
Elaboration time... I did this in the UK, similar likely applies in the states. I used to be an 'independent contractor'. I work for companies doing ecommerce / Java / Consulting work. I work a fixed term contract and leave when the project is complete. I set up a limited liability company with me as the director and the only employee. When I get a contract (work), the client hires my company rather than hiring me directly. Depending on your specific tax laws, you pay a lot less tax using this kind of setup i.e. you pay yourself a low salary and the rest in (low tax) dividends. This is the standard way most IT contractors operate.
- gk1 12y ago
  I'm not even remotely close to being a lawyer, but I thought in the US a single-member LLC is taxed the same as a sole proprietor.
  - JamesSwift 12y ago
    By default, yes, but you have the option to elect as a corporation.
    - neltnerb 12y ago
      Noting that if you're expecting to lose money on the business initially, I believe you can't write that off on your personal taxes if you're not taxed as a partnership. I think it is common to have an LLC taxed as a partnership initially and switch to being taxed as a corporation (which you can do I think within the first few months of each year) after it becomes profitable. (IANA Lawyer or Accountant)
  - wslh 12y ago
    There is another trick not mentioned here. If you live outside US and have an LLC with only one person you don't pay taxes in US. This works assuming your work is done outside US. So, say you live in a very relaxed tax environment, you can incorporate your LLC, sell software services to US companies and pay small taxes in your country.
deleted 12y ago
[deleted]
larrykubin 12y ago
I disagree and think this is completely wrong. I've paid a ton of self-employment tax and the write-offs for a web developer have never made me better off than someone who makes 100K and doesn't pay self employment tax. An employee making 100K and paying regular taxes and low state income tax probably has over 70K left over after taxes. How can someone making 70K pre-tax that has to pay self-employment tax do better than someone who gets > 70K after tax?
- deleted 12y ago
  [deleted]

jdreaver 12y ago

Can you expand upon that? I am always looking to reduce my taxes. I got killed with my 1099s this year.

adwf 12y ago
I can't speak for American tax law, but in the UK there are some common methods of small business owners reducing taxes on income: Small payroll income so that you fall within a low income tax bracket. Top up salary with dividends as they have a much lower rate of tax. If you have a live at home wife, make sure she's employed by the company in some form, eg. you can pay her the minimum wage for secretarial duties. Ideally falling within the tax-free lower bracket. Unlike regular employment, you can start claiming a lot of everyday things such as food/transport/home office electricity/internet/etc. as business expenses, thus meaning you can claim 20% VAT (sales taxes) back depending. Ultimately, there's also the final payout if you manage to sell the company. If it were classed as regular bonus income, you'd be taxed at 45%. Instead you get charged as capital gains at 18-28%. You can also get entrepeneur relief on the first £10m which means you only get charged 10% instead of 28%. NOTE: Some of these are loopholes like dividends and employing family. They tend to get cracked down on every now and again (I'm not even sure if they're valid now) But when you get down to it, there are a heck of a lot of potential savings over standard income tax (currently 40% on anything over £32k, 45% over £150k)
- jhome 12y ago
  I would appreciate if someone could correct me on this as this is mostly from memory. I believe the using dividends for tax avoidance is either no longer effective or has been cracked down upon. You can also give less to the government on your VAT if your profit (or revenues, I can't remember which!) is below 150,000 GBP. Rates vary between 9% and 15%.
  - adwf 12y ago
    Yep, they crack down on stuff all the time. Still slightly worth it as far as I know. You pay standard 20% income tax on the first £32k (with first ~£10k tax-free), then 40% upto £150k, 45% over that. Whereas with dividends you pay 10% on the first £32k income (minus allowances), 32.5% on everything upto £150k, 37.5% over that. So it's still worth it, but not quite as much as it used to be before IR35.
    - majc2 12y ago
      Anyway, anyone going down this line really needs to speak to an accountant, yada yada yada. For consultants/freelancers/contractors - dividends can be fine, if you can mitigate your exposure to IR35 (typically a bigger issue for contractors). Groups such as the PCG can really help here, but really the key thing is ensuring that any contract can't be thought of as disguised employment (control, substitutability and mutuality of obligation being the keywords) - speak to a Lawyer or a specialist accountant for advice or other clued up contractors for advice. The tax position on dividends is also a bit more subtle than above; if your total personal income is less than the £32k (minus allowances), then you're going to get the dividend tax credit back so the div is tax free. Granted the company is paying corp tax at 20% on all profits; but also it gives you options to defer company income becoming personal income, building up the company's reserves. As I understand it, you can wind up the company and get entrepreneurs relief which is also a worthwhile target for consultancies.
greenyoda 12y ago
If you're legitimately self-employed (see second paragraph), you should be able to deduct all your business expenses - home office, hardware, software, phone, travel, advertising, legal fees, etc. - on your Schedule C. You can also set up a self-employment retirement plan (SEPP IRA) and contribute to it.[1] You'll need good records in case the IRS questions your expenses, and you'll need to keep your work life separate from your private life (e.g., your home office space must be used solely for work; if you use your car for both business and personal trips, you'll need to log your business mileage). I'm assuming your work is legitimate self-employment, i.e., the people who pay you do not control your hours, tell you how or where to do your job, etc. If that's not the case, the law probably considers you an employee rather than an independent contractor[2], and you should be paid as one (W-2) - and you could get in trouble if you try to deduct expenses that are only valid for an independent contractor. (I'm assuming you're self-employed, not incorporated.) [1] http://employment.laws.com/self-employment http://employment.laws.com/self-employment [2] http://blog.intuit.com/employees/1099-contractor-vs-w-2-employee-a-decision-guide http://blog.intuit.com/employees/1099-contractor-vs-w-2-empl...
jakejake 12y ago
(Sorry in advance for this long, rambling response) This applies to the US and forgive me if you have already done some of this. The first step is to get your corporation set up (use an online service or an accountant). It's a bit of paperwork but you can do it for around $400. Once you do that you can open a corporate bank account. At that point you bill your clients as a corporation and provide them with your corporate tax ID instead of your personal SS. The money goes into your business account. Then to pay yourself, the next step is to setup payroll (easiest way is to use an online service like quicken payroll) which will run you about $50/month but will handle all of your withholding and tax filing requirements. It's somewhat of a pain getting this all going but once you do, you are operating as a corporation. Corporations do not pay income tax as such - they do have some filing fee type of taxes, but basically the taxes you pay come out of your payroll. So you do not pay tax on income that your company earns until you withdraw it from the company account via payroll. However, you can spend directly from the corporate account on anything that is reasonably considered a business expense. Computers and equipment, of course, can be purchased. Your company can pay the phone bills, internet connection, travel expenses, business lunches, etc. You can also charge your company rent as well if you are working out of your home. What happens is that you wind up paying yourself a meager salary on which you pay normal tax just like everybody else. So for instance, your company earns $80. You pay yourself a salary of $15k and the remaining $65k money is spent on operating expenses and is a tax write-off. You only pay tax on that $15k. You're likely to even get a small tax refund check instead of a huge bill from the IRS. In some extreme cases you might pay yourself even less, or even come in at a loss and pay no income tax. There is nothing illegal about this as long as your write-offs can be legitimately considered a business expense. This is also great because with payroll setup you are in a position to pay employees and sub-contractors via payroll as well and eventually grow your company with the proper financial system in place. I would highly recommend having an accountant set this up for you and file your taxes though because it is a ton of work and requires understanding the ever-changing tax laws.
- hluska 12y ago
  > Corporations do not pay income tax as such - they do have some filing fee type of taxes, but basically the taxes you pay come out of your payroll. Are you sure that is correct? I am neither an accountant, nor even American, but IRS.gov says: "The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation." (source - http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Corporations http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employ...) For the 2011 tax year, Wikipedia pegs the US federal income tax rate at between 15% and 35% (depending on income level). (source - http://en.wikipedia.org/wiki/Corporate_tax_in_the_United_States http://en.wikipedia.org/wiki/Corporate_tax_in_the_United_Sta...) I think that only applies to C corporations, though I'm curious now about US tax law. Do tax shelters like you propose exist? Do you have any more information??

nicksergeant 12y ago

I would also like to see some examples. If you're just writing code all day, you have an awfully low overhead. I lose over half of my side income after I hit a certain point that's covered by my deductions, at which point I simply stop doing side work.

mattdanger 12y ago
In the US if you have a mortgage and/or office in your house you can take additional deductions. Contributions to an individual 401k are deductible.
- nicksergeant 12y ago
  Certainly. And I do that. But after a point, you're losing a ton of money by not having enough deductions to cover your income.
  - dwd 12y ago
    Which puts you in the same position as an employee paying top tax rates. It's the pre-tax deductions (cost of doing business expenses) that differentiate working for yourself or for someone else.
    - nicksergeant 12y ago
      But those pre-tax deductions are pretty limited in the software development field. More code written != more deductions taken.

gr2020 12y ago

Can you elaborate on this?

croggle 12y ago

Elaboration time... I did this in the UK, similar likely applies in the states. I used to be an 'independent contractor'. I work for companies doing ecommerce / Java / Consulting work. I work a fixed term contract and leave when the project is complete. I set up a limited liability company with me as the director and the only employee. When I get a contract (work), the client hires my company rather than hiring me directly. Depending on your specific tax laws, you pay a lot less tax using this kind of setup i.e. you pay yourself a low salary and the rest in (low tax) dividends. This is the standard way most IT contractors operate.

gk1 12y ago
I'm not even remotely close to being a lawyer, but I thought in the US a single-member LLC is taxed the same as a sole proprietor.
- JamesSwift 12y ago
  By default, yes, but you have the option to elect as a corporation.
  - neltnerb 12y ago
    Noting that if you're expecting to lose money on the business initially, I believe you can't write that off on your personal taxes if you're not taxed as a partnership. I think it is common to have an LLC taxed as a partnership initially and switch to being taxed as a corporation (which you can do I think within the first few months of each year) after it becomes profitable. (IANA Lawyer or Accountant)
- wslh 12y ago
  There is another trick not mentioned here. If you live outside US and have an LLC with only one person you don't pay taxes in US. This works assuming your work is done outside US. So, say you live in a very relaxed tax environment, you can incorporate your LLC, sell software services to US companies and pay small taxes in your country.

deleted 12y ago

[deleted]

larrykubin 12y ago

I disagree and think this is completely wrong. I've paid a ton of self-employment tax and the write-offs for a web developer have never made me better off than someone who makes 100K and doesn't pay self employment tax. An employee making 100K and paying regular taxes and low state income tax probably has over 70K left over after taxes. How can someone making 70K pre-tax that has to pay self-employment tax do better than someone who gets > 70K after tax?

deleted 12y ago
[deleted]