Tax Avoidance Strategies for Small Businesses, Like Your Advisory Firm

After estimating my 2011 federal tax liability, I made it my mission to find a legitimate way to reduce the amount I send to Washington. What I found was encouraging. If your current business form is a pass through entity, you are paying taxes at the personal level. If this is the case, this could be especially beneficial. A C Corp is taxed at 15% up to $50,000 and at 25% on the next $25,000 (up to $75,000). The concept is to divide your income over multiple entities. Here’s the basic strategy. 

The Case Study

Assumptions:

Gross Income: $175,000

Business Overhead: $40,000.

Individual Filing Status: Married Filing Jointly

Itemized Deductions: $25,000

Personal Exemptions: 4 (@ $3,700 each)

Tax Year: Calendar Year 2012

Social Security Wage Base Maximum: $110,100

Medicare Wage Base Maximum: Unlimited 

This is a very basic example, so we’ll forgo any tax credits, retirement plan contributions, etc. First, we’ll look at the tax liability using a pass-through entity. Then we’ll use the same facts when you include a C Corp. 

Pass-Through Entity Only

Federal Income Tax: As a pass-through entity, you’ll claim your business deductions on Schedule C. After deducting your overhead, your net self-employment income would be $135,000 ($175,000 – $40,000). This amount is entered on your 1040 and is reduced by your itemized deductions and personal exemptions, leaving a taxable income of $95,200. The resulting federal income tax liability would be $15,860. 

Social Security Tax: The 2.0% “payroll reduction tax” applies to “employees” only. Therefore, using the Social Security maximum wage base amounts, your SS tax liability would be as follows: Medicare tax $3,915 and Social Security tax $13,652. The total Social Security tax would be $17,567