The reason for this is actually extremely simple and direct: Taxes
If you could consistently make 20% MONTHLY returns in the stock market you’d still benefit from a small business. Realistically, I can’t think of a single reason not to own a small business. Even if the business only employs you, there are tax advantages though there are certain advantages, such as healthcare, that are only possible with people working with you.
Keeping in mind that less than 12% of millionaires, according to The Millionaire Mind, are professionals (i.e. doctors, lawyers, engineers, etc.) and the vast majority create their riches through building a business, that’s actually beside the point. My point in this blog is simply that owning a brick and mortar business has many advantages that even your 1-man-show-no-employees-to-deal-with internet business can’t match. Let’s look at a few:
- Room to cutback
- Health Insurance
- Retirement Accounts
The quantity of tax advantages possible with a small business are for more numerous than a short blog can cover so I’ll touch on a few highlights:
- Pre-tax Expenses – Your gross pay is meaningless. Your net pay is all that matters and when your phone, internet, car, car insurance, business meals, and travel are all paid for by your business the savings are huge. As an example, if all of those pre-tax expenses add up to only $10,000 per year and you are in the 30% Federal Income bracket, have 5% state income tax and have to pay 15.3% in FICA (7.65% from the employee and 7.65% from the empoyer) you’d have to pay yourself over $20,000 in salary to afford the same expenses. If you own a business and those expenses only amount to $10,000/year you probably need a better accountant. Keep in mind you have to be honest about the use of those items. For instance, my company doesn’t pay for my entire cell phone bill because obviously I use the cell phone personally a portion of the time. The same is true for my vehicle allowance.
- Distributions – When you have a pass-thru entity you have to pay yourself a “reasonable” salary and the rest of the profit you can take as a distribution without paying any FICA tax (a savings of 15.3%).
- Racing – This is probably my favorite! In essence, if you like racing cars, motorcycles, airplanes, bicycles or have some other hobby and you don’t mind plastering your race vehicle with your business’ logo, then your vehicle and most of the expenses related to racing can be paid for pre-tax as a marketing expense for your business.
- Real Estate – If your business requires a building and you own the building in a separate entity (most likely an LLC), your business can rent the building from your other entity and the rent is passive income that isn’t subject to FICA (again saving you 15.3% over a salary). Obviously the rent has to be reasonable.
As you can see, just these few items can quickly add up to tens of thousands of dollars in tax savings even with a business grossing less than $500,000 per year. Obviously, the larger the business, the greater the savings.
By room to cutback, I simply mean that if you have a business that employs just you and sales drop, guess who the first one to get fired is? On the other hand, if you have a business with just a dozen employees and sales start dropping now you have a lot more room to cut payroll before you’re out of a job or taking a pay cut. As a small business owner, I know personally that cutting others before you cut your own pay is extremely difficult to do, but you can’t deny that, if necessary, you and your family have a bit of extra security.
As for health insurance, if you have a few employees (at least prior to the new Healthcare Reform Bill) there were health insurance advantages to being on a group plan such as your rate is primarily based on your age and not pre-existing conditions. I learned this first-hand as I couldn’t get insurance as an individual but had no problem getting on my business’ plan.
Since it’s your business, you get to structure your SEP-IRA or other retirement vehicles in any way that you want. Of course you have to make the accounts available to everyone on your team, however you have the ability to structure the accounts to best benefit you. This power can have a major impact on your overall tax bill today and into retirement, so don’t overlook it.
Finally, if you’re looking for what type of entity to create, I highly recommend an LLC filing as an S-corp. Also, make sure you have a GREAT accountant to take care of all of the details of these tax advantages and to make sure you’re doing everything legally and ethically.
To your tax-saving success, Bryan