In this edition of the podcast, we’ll be focusing on the key considerations that are a part of the business entity formation process while we look in detail at the S-Corp Election. You’ll be hearing from the Trucker CFO, Colton Lawrence, Colton will also be joined on the podcast by Robert Hazen, a member of the team at the Trucker CFO. Greg Thompson, the Executive Producer for PodWheels Powered By RadioNemo, will be asking questions and Greg will serve as a tour guide for the conversation.
Welcome back to the Trucker CFO Podcast, and thanks for connecting with us again through PodWheels: Powered By RadioNemo. As we’ve shared with our listeners in previous episodes of this series, the Trucker CFO Podcast is focused on exploring the business, accounting and tax topics that matter most to truckers – particularly the men and women who move the nation’s economy as owner-operators, independent contractors and professional drivers. This podcast is also dedicated to the business needs of the fleet owners and small trucking businesses throughout the country.
In this edition of the podcast, we’ll be focusing on the key considerations that are a part of the business entity formation process while we look in detail at the S-Corp Election. You’ll be hearing from the Trucker CFO, Colton Lawrence, Colton will also be joined on the podcast by Robert Hazen, a member of the team at Trucker CFO. Greg Thompson, the Executive Producer for PodWheels Powered By RadioNemo will be asking questions and Greg will serve as a tour guide for the conversation.
As you listen to this discussion, please keep in mind that what is being shared through this podcast is general information regarding the S-Corp election. The content of this podcast episode is in no way, shape or form to be considered legal advice. When it comes to the process of making decisions related to the S-Corp election or your choice of business entity, owner-operators should utilize the services of qualified business advisors and engage legal counsel.
Now, before we join the discussion with Colton, Robert and Greg, we have one other point to keep in mind. As always, the Trucker CFO Team reminds our listeners to please understand that every tax and business situation is unique. In addition, the perspectives shared on this podcast should not be considered as tax advice. If you have questions regarding your specific tax situation, you should consult a qualified tax professional. At the close of the podcast, we’ll be sharing information on how you can connect with the team at Trucker CFO.
Now let’s join Greg Thompson for our conversation with the Trucker CFO, Colton Lawrence, and Robert Hazen from Trucker CFO.
Welcome back to the Trucker CFO podcast. As you heard in the opening, we're talking about S-Corp, we've got the Trucker CFO himself, Colton Lawrence here, Colton, it's good to be back with you on the podcast. We have one of your team members, Robert Hazen who will be joining us in a moment. We're talking about S-Corps and Colton as you know, S-Corp is one of those entities that sometimes gets overlooked by entrepreneurs because as we know, folks come into this industry and they start their trucking businesses, they start small trucking businesses with an LLC or a Sole Proprietorship. Very easy to do, but as we grow, things can get more complex. When you have a lot of money coming in, there are advantages with S-Corp and sometimes in the busy world of doing business and trucking an entity like an S-Corp can get overlooked.
Greg. It sure can. And I'm really excited to talk about this topic on our podcast because it is really one of the exciting tools we use to help folks plan for and save a lot on their tax bill. We have had a podcast in the past, in fact several podcasts in the past where we have touched on the S-Corporation, but we're going to reset again this topic. Talk about some of the things people should be considering and doing. Why they should be looking at S-Corporation and talk about some of the tools we use to help folks in implementing these tax savings that come from the S-Corp election.
Well Colton, let's start right at the top. We need a definition. So, what is an S-Corp?
Greg, this is one of the areas where a lot of folks get confused. Some folks are of the understanding that an S-Corporation is an actual entity. That just like an LLC or a C-Corp, you're going to go to your state and you're going to set up an S-Corporation. But for purposes of this conversation, when we talk about an S-Corporation, it is actually a tax election. It is something that we tell the IRS we want to use for a particular entity. It might be an LLC, it might be a C-Corporation, but we are telling the IRS that we want to change the current tax filing status of an existing business entity to a different tax status and that tax status happens to be the S-Corporation. And what it does is it changes the way you are taxed currently, depending on the type of entity you are and fall under now the rules of an S-Corporation. Depending on what type of entity you are. Those changes are going to vary. Usually our clients come into the situation filing as an LLC. And as such, it's important to understand that the IRS does not have a specific tax classification for LLCs.
They group you into one of two different types of tax filing situations. As a single member LLC you are going to file as a sole proprietor. That's very much the same way as any other truck driver who does not have a business entity set up, would file. Your income and expenses are going to be reported on a Schedule C. And that Schedule C then flows through to your personal tax return. A multi member LLC is going to file as a partnership. That is going to be a separate tax return that is going to generate what are called K-1s. And those K-1s then flow through to your personal tax return and that is where the income is reported and that is where you pay tax.
For both of those types of entities. It's important to understand that you are subject to self-employment tax in addition to income tax. And that self-employment tax is the way you pay into Social Security and Medicare. And that self-employment tax is going to be calculated at roughly 15 percent of the net income from either your Schedule C or your partnership tax return. So, having now just touched on self-employment tax, I think it's a good opportunity to introduce the other member of this group here, Robert Hazen from Trucker CFO. Rob, what do you have to add on the subject of self-employment tax?
Thanks Colton. One of the questions that we hear all the time and one of the biggest shocks people have is due to that self-employment tax. If we were just to use an example, a driver was making $50,000. If they were to make that same $50,000 driving for a carrier, that self-employment tax would be the Social Security and Medicare tax, which works out to be 7.65 percent. Well, what the driver doesn't see is on the back end, the company is also matching that 7.65 percent. Just because the driver is self-employed, it doesn't mean that the IRS does not want that money so they still have to pay that. And that Social Security and Medicare tax for both the driver's side and the employer side is what makes up that self-employment tax. So, that's how we come up with that 15 percent. And as you look at the tax return that really becomes a costly and a heavy part of the tax return and the balance due for our clients.
Rob, you touch on a very important point there. And that is that too often folks don't have the understanding that as a self-employed truck driver, an independent contractor, owner-operator, whether they're driving for a motor carrier or have their own authority, they are in business for themselves. They are both the employee and the employer.
And in the case of this calculation for self-employment tax, as you mentioned, they have to cover both sides of that equation. The 7.65 percent for the employee and the 7.65 percent for the employer. And again, is how you get to that roughly 15 percent of self-employment tax. And that adds up real quick. You use the $50,000 threshold. At $50,000, 15 percent of that is $7,500. So, your tax bill is $7,500 before you even get to any consideration of income tax.
That's where folks really end up having that sticker shock when it comes to seeing their tax liability, if they are new to the owner-operator, independent contractor world. Something they've been doing as a company driver for most of their lives. It's all fun and games and sounds nice to be self-employed, but if you don't understand these things and know how to plan for it… It can catch them by surprise and, as I say all the time when I'm on the radio or doing these podcasts, there's nothing business likes less than surprises.
Well guys, what you shared here is very eye opening. First of all, we mentioned $50,000 as net income as an example. But I want to dive in a little deeper and let's talk about recommended net income, where this comes in. What are the requirements and why should somebody who's in business look to do this?
Greg. Thanks for that question because, in order to even start having a conversation with a client about making an S-Corp election, there are certain things they have to have in place first and it all starts with a business entity. A lot of folks, when they jump into business for themselves, maybe they go to a motor carrier and they start driving for that motor carrier. They are doing so as a sole proprietorship. And as I mentioned, there's no tax difference between filing as a sole proprietorship and filing as a single member LLC. Because of that, we oftentimes get questions about, well, why do I need to set up an LLC? Why should I go to the cost of setting up that LLC with my state?
The additional requirements that come with the annual filings depending on your state. There's extra work that comes with setting up that LLC. And, sometimes, folks just don't want to go to that hassle and that's fine in certain circumstances. But, before we can even have a conversation about tax savings that come with the S-Corporation, they need to have that business entity in place. Because the benefits that come with the S-Corporation do not start until the election date.
Usually, it's the date on your SS-4, which is the letter you get from the IRS containing your EIN. That is the date, that in terms of the IRS, as far as they're concerned, that's the date when your LLC or your business entity started. And that is the time the clock starts ticking for you to make this S-Corp election.
The IRS looks at both a timely filing and a retroactive filing. In order to have a timely filing, you have until the 15th day of the third month after you set up your business entity. A little bit confusing, but effectively it's somewhere between two and 2.5 months for you to make that timely filing as an S-Corporation. If you are not able to make that timely filing, it's okay. We make retro elections all the time on a regular basis. There are specific ways you have to go about this. Very specific steps you have to follow.
This is one of those places where you really got to make sure that you have crossed all your T’s are crossed and your I’s are dotted because most of the mistakes we see come from the process and steps you have to follow to make that retro S-Corp election.
Rob, I think this is a good point again to bring you in. What insight do you have when it comes to making an S-Corp election? The timely filing and a retro election.
Colton, I think one of the big things that you touched on is just the flexibility that an LLC gives the driver. When people start their business, they always have big dreams and aspirations of growing that business. Well, it isn't necessary to jump right into the S-Corporation right away, but, creating that LLC, gives them the flexibility that as they grow. They do have that flexibility to make that conversion and file that election with the IRS to be taxed as an S-Corporation.
Rob, it's a very good point. Oftentimes, people are just kind of flying by the seat of their pants and they don't realize that there is structure to what we are recommending to them. You can't just one day decide you want to be an S-Corporation. You've got to plan. You've got to have a plan in place. We talk all the time on our podcast about the need to have a plan. And this is one of those plans. You may set up an LLC and not decide to make an S-Corp election until 3, 4, 5 years down the road based on the requirements that we're going to talk about. But you need to have it in place. And once you have it in place, it gives us that flexibility that you mentioned Rob, to do all kinds of things that they're going to save the business money when it comes time to pay the tax bill.
Yeah Colton, a couple other mistakes that we see quite often is maybe a business has already established that LLC, but they haven't taken that extra step to let their carrier know that they do have an LLC, and they're not being paid to that LLC. So, we want to make sure that once that LLC is set up, that they let their carrier know, making sure that their earnings are paid to that LLC and the associated tax ID number.
Great point Rob. And that is something we see all too often. We receive these 1099s from the motor carriers and it's being paid to the Social Security number when, in fact, the person has paid the money to set up the business entity. However, they haven't taken those extra steps to get the carrier to pay the correct entity. And that is very important when it comes time for us to file the taxes. It's not something that's insurmountable, but, just to keep things clean and do things right, they need to take that extra step.
Colton, you mentioned just a moment ago about the retro process for S-Corp. Is there a time limit on retro? Is it limited to two years? Is it three? If you've had an LLC for 10 years and you suddenly have some growth and you look at this and say, man, I see the tax advantages of the S-Corp…. How far back can you go with retro?
Greg, that's a great question, and I'm gonna turn that question over to Rob to start out with the answer and then we'll have some discussion on it.
A lot of our drivers, whether they're coming out of orientation or in this environment of unknowns, they don't know what the revenue will be through the year. Giving your example or giving your situation to where the S-Corp must be filed by March 15 of the current year. A lot of times they don't know what their net income will be by the end of the year. So, by doing this, it gives us the flexibility that, let's say, that, if the driver were to add a dedicated route or get a new truck part way through the year, they still have the flexibility of going back and using the revenue procedure that we talked about.
Rob, just to be clear… First of all, is that to be in a position to do this, you got to move from a sole proprietor to taking that step with an LLC. And let's say that you've been in business six or seven years as an LLC. Everything's rocking along fine. All of a sudden, as you said, the owner has an opportunity to add three trucks. All of a sudden, my revenue is like tripled. If I want to go and execute this S-Corp election, I can come to you at Trucker CFO and you can help us do it. But I don't have to go back to the beginning of my business. I can just do it for that current year and going forward. Is that right?
That's correct Greg. The key to this is that we do have that flexibility. So, like you said they must have an LLC. And they don't have to go back to the beginning of the LLC. But there is flexibility to go back up to three years. But, most commonly, we just see it in the current tax year when it's time to prepare the tax return.
Well guys, that was a great conversation and I think our clients have a pretty good understanding of how the S-Corp election works and when they should do it. So, just to kind of wrap this up for them, we're going to use an example of some clients that we have seen over the course of this past tax season.
One that comes to mind is a couple that we met actually out at the Mid-America Truck Show. They had had their tax return filed for 2021. That tax return was filed as a partnership and it passed through to their personal return, where they incurred a self-employment tax bill of about $18,000. In talking to them out at the Mid-America Truck Show, they had some concerns about their tax bill. They felt that it was too high.
We took the time to review this couple's tax return that had been prepared by a competitor in the industry that many of you folks know. They've been around a long time. Unfortunately, they have not taken the time, and this is a very common thing that we see happen where folks are just a number to this competitor, and they are not worked with in a way that allows them to take advantage of the options that are available to them.
In this case, it cost these clients $18,000. That is not a small amount of money to anybody I know. So, we decided to work with them, making the changes necessary to file an S-Corp election retroactive to January 1st of 2021. And in doing so, it eliminated that self-employment tax.
A pretty simple fix from our perspective, but something that the average person doesn't know about unless they know the industry. You have to know how to work with truckers. We try to help them save as much money on their taxes as possible.
We've got example after example just like this one. The numbers vary, depending on those situations, but, in most cases, it's many thousands of dollars that we're looking at, that people can save by simply having an LLC in place to begin with, and then taking advantage of that LLC to file as an S-Corporation if the situation merits it.
So, Colton, we've talked about the what's, the who's, the whys, and the advantages of the S-Corp. And you've given us an example that clearly shows us the advantage of doing it. Walk us through the process of somebody coming in to you guys whether it be tax season or not. How do you go about evaluating whether or not the S-Corp is right for them at the time, or it's something that you put on the radar for them, maybe a year or two in the future?
Well Greg, there's all kinds of things out there in the industry. It can be other competitors, other accountants, things they look at. For us, what we're going to do is we want to take a look at their profitability. It really comes down to that.
When somebody exceeds a certain threshold of income, it then becomes beneficial to them to take a look at the S-Corp election. In our mind, that threshold is $70,000 per year of net income. That's important to understand. It's not gross income. It's not what you're receiving from the motor carrier or from your factor or from the brokerage company that you might be getting your freight from. It's not the total of all the loads that you're hauling.
It is the total of all the load you're hauling after your expenses. After you've paid for fuel and your truck lease or depreciation. After you've paid for insurance and all those kinds of things. If the amount that you have left over is $70,000 or more, we are going to then take a look at and recommend you make an S-Corp election. And that $70,000 is not set in stone.
There are certain circumstances where we will come below that $70,000. Maybe there are circumstances where we won't recommend it until you're above the $70,000. But it kind of starts at that point. So, we will work with them to understand their business and when they might benefit from making that election. But again, it starts with $70,000.
Yeah Colton, like you mentioned that $70,000, we've set that as the break-even point because, like all good things, there are some downsides and some of those downsides are additional compliance costs. The taxpayer must have reasonable compensation. They must have some sort of a payroll company. There will be an additional compliance costs as far as a tax return. They'll need to file a S-Corp tax return. So, that $70,000, like you said, it's not set in stone. But, that's the break-even point to where it starts making sense to where the tax savings exceed some of these additional compliance costs.
Yeah, so when I have these conversations with clients, Rob, and I know you've listened to me have these conversations. I've listened to you have these conversations and we touch on many of the same points. But it really comes down to this: Does the savings that somebody is getting from making the S-Corp election outweigh those additional costs? And those costs can seem a bit overwhelming in terms of the headache it might bring to somebody's business.
But, as we have this conversation, remember these are things that we at Trucker CFO are going to handle for the clients. These aren't things that they have to do. They just simply need to understand what it means to them.
So, you mentioned payroll and reasonable salary. One of the owners that makes this election has to set themselves up to receive a salary out of the business. They effectively become a company driver of their own business. The amount of salary that they need to take is going to be dependent on how much net income they have. But it really needs to be no less than what would reasonably be expected to be paid if they were to go drive as a company driver anywhere else. And it can be on the low end of that. You can push the envelope a bit.
Now, you can't pay yourself $10,000 a year. That's just not reasonable. So, we see those salary amounts somewhere in the $35,000 to $50,000 a year range as being reasonable in doing that. You are paying FICA which is Social Security and Medicare. So, you are staying compliant with the IRS in terms of your contribution, your continued contribution to Social Security and Medicare. And there's a cost that comes with that.
There's that payroll tax on $40,000 a year. You're going to have payroll taxes of about $6,000 a year. You're going to have the cost of the payroll services themselves, which are going to run you about $1000 per year. And then, if you've been filing as a sole proprietor on a Schedule C, you also are going to have the additional cost of a second tax return.
That second tax return is going to run you about $600 per year. So, when we add all that up, you've got $6,000 of payroll tax, you got $1,000 of payroll expense. Now you're at $7,000. You got $600 of the extra tax return potentially. So now you're at $7,600. You also have to factor in that as an S-Corporation, you are not eligible to take the per diem deduction in the same way that you've been taking it. So, we're going to actually build the per diem into your salary that effectively comes in as a tax-free distribution out of your company. But you have to do that in a very planned way so you can take advantage of it and still get those savings.
So, $7,500 or so roughly in expense that you're going to incur by making this S-Corp election. But it's $70,000 a year of net income. You are now saving about $11,500. You can see that there's an ROI on this change that is going to come into the tune of about $4,500 each and every year. And you are going to save in tax moving forward. That adds up over time.
Colton, I don't know about you, but this is about the point in the conversation that I have with the client where their eyes start rolling back in their head and they start getting a little bit confused about what needs to be done.
The thing that they need to understand is, yes, this is not simple, but one thing that we do at Trucker CFO is, will help them along the way. We work with an outsource payroll company. We’ll tell them exactly how much their payroll needs to be. We’ll let them know when the deductions will come out. We'll make sure that the compliance issues are taken care of, that their quarterly taxes will be filed. Their W-2s are issued. We'll figure out that reasonable compensation. So, that's something that they can trust and they can lean on here at Trucker CFO. Yes, it is complicated. Yes, the benefits are great in the tax savings, but we're also going to assist them along the way to make sure that it's done properly and they're not on their own.
Rob, you make such a good point because the last thing we want is for somebody to not take advantage of this option simply because they feel overwhelmed by it. We're not going to let them be overwhelmed by the changes that come from making this election. We're going to make it as easy as possible. Does it require some effort on their part? Sure, but that effort is well worth the savings that they're going to get of $4,500 or more per year. In our minds, it's well worth some of the complexity that comes with making this change. We can have further conversation with them to make sure they understand it. We talk about how that's going to impact their money. How that money is going to flow. Work with us and we will work with you and you can save a whole lot of money.
Well, Colton and Rob, we've covered a lot of ground here. Colton, I have one last question for you, and that is if I'm sitting out there and I have my LLC or I'm thinking about forming an LLC and I'm seeing success out there? How can I explore the possibilities of the S-Corp with Trucker CFO?
Well, they need to contact us here at Trucker CFO and we will have an evaluation with them. We can review their prior year tax return, we can review their bookkeeping that's been done for the current year, and have that discussion as to whether or not we feel it's in their best interest to make the S-Corp election now, or if they should wait until the stars aligned such that it would be better for them to do in the future.
That’s Colton Lawrence, the Trucker CFO, closing out this edition of the Trucker CFO Podcast. We'd like to thank Colton and his guest Robert Hazan for their time and perspective.
As we noted in the opening of the podcast, please keep in mind that every tax situation is unique. And the perspective shared on this podcast should not be considered as tax advice. If you have questions regarding your specific tax situation, you should consult a qualified tax professional. In addition, please remember that what we shared through this podcast should only be considered as general information regarding the S-Corp election and business entities. This content should not be considered as legal advice. When it comes to the process of choosing a business entity, owner-operators should utilize the services of qualified business advisors and engage legal counsel.
Before we close out this edition of the podcast, we would like to take a moment and tell you more about Trucker CFO and the scope of services provided by the Trucker CFO Team.
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Also, through the TruckerCFO.com website, you can connect to the company through the find time to talk button to set up an appointment or you can use the chat feature. If you would rather email the Trucker CFO Team directly, you can reach out to the company through the following address email@example.com.
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The Trucker CFO Podcast is produced by PodWheels Powered By RadioNemo in collaboration with the team at Trucker CFO.
Before we close out this edition of the podcast, please keep in mind that every tax situation is unique and perspectives shared on this podcast should not be considered as tax advice. If you have questions regarding your specific tax situation, you should consult a qualified tax professional.
Thanks again for joining us on the Truckers CFO podcast. Just as a reminder, you can find and subscribe to our podcast through all major podcast platforms. If you do become a subscriber, we'd like to ask you to take a moment and rate the Truckers CFO Podcast. Throughout 2022, Colton Lawrence, the Trucker CFO, will be making regular appearances and taking calls for professional drivers on the Dave Nemo Radio Show and the Tim Ridley Show. Both of these programs are part of RadioNemo and they can be heard through SiriusXM’s Road Dog Trucking Radio. All of the programs from RadioNemo can be heard in the mornings on Sirius’sXM channel 146 or through the SiriusXM app.
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As always, Colton Lawrence and the entire Trucker CFO Team wish you the best for continued safe travels and good health as you work to keep the American economy on the move.