Speaker 1: If you're thinking of starting your own roofing company or any other small business, you should give careful consideration to the type of business structure that you select for your company. Some business structures can give you low overhead costs, while others can give you great asset protection, and still others can give you some tax savings. Knowing which one to pick and when to switch is really important for your small business because it can save you a significant amount of money. Now here at Grand Roofing, we've gone through all the different business structures during our business lifecycle. So we're going to try and walk through these with you today. Now I'm not an accountant and I'm not an attorney, so make sure and run any of this past your accountant or your attorney before you implement it for your small business. Let's go ahead and get started. Okay, let's go ahead and talk about the three most popular business structures for small businesses. Sole proprietorships, LLCs, and S-Corps. In our examples of different business structures, we're going to use Joe's Roofing, and we're going to assume that Joe's Roofing is married, filing jointly. In his first box, Joe's Roofing has all of his income and his expenses, and that pours out to this box, which is your net profit of $100,000. Now the first thing that Joe's going to have to do is pay his self-employment tax, or SE tax, which is 15.3%. That 15.3% is made up of Social Security tax, which is 12.4%, and then Medicare tax, which is 2.9, totaling 15.3%. So that's $15,300 in self-employment tax. Now there are a couple of deductions that you will get on your SE tax form. One of them is a mathematical deduction, where they'll multiply your net profit by 92.35%, kind of knocking down the amount of tax that you have to pay, and then that ends up saving you about $1,170.55, so not a huge savings, but some savings. And then you get a 50% deduction, where you multiply your SE tax by 50%, and then you run it through your federal tax rate of 22%, which is a total of $1,683. Now you need to be careful with this, because I've seen a lot of other videos that claim that you get a 50% deduction on your taxes, and you want to make sure that it's clear it's not a 50% deduction of SE tax. Like in this example, it only adds up to $1,683, not half of 15.3. And you can look at the bottom line of your SE tax form to see where it has you pump it over to your Schedule 1, and then from your Schedule 1 it goes to your 1140, where you actually only get the 22% federal tax deduction off of that 50%. So anyways, the total is $12,446.55 after deductions for SE tax. Then Joe has to take the $100,000 and bring it down through the federal tax rate of 22%. That's an additional $22,000 in taxes. So Joe's total taxes are $34,446.55. Joe will get to keep $65,553.45. So that is the total tax rate and how the tax structure flows for sole proprietorship. Now let's talk about asset protection as a sole proprietorship. So let's say that Joe's roofing does a roof on a house, and they don't do a very good job. This is actually one of those roofs that would end up on one of Brian's videos where he shows world's worst roofing. And let's just say for argument's sake, the guy who he did the roof for goes on vacation, he's gone for a month, he comes back and the house is destroyed. That's a total loss and he sues Joe's roofing for $400,000. The question is, can he sue Joe's roofing being a sole proprietor? Yes he can. Can he take all of Joe's assets on the roofing company? Yes he can. But can he get to Joe? Because Joe's sitting up here and Joe has a house and cars and cash. Can he pass that judgment that Joe's roofing cannot cover on to Joe himself? And the answer is yes. As a sole proprietor, there's absolutely no protection for Joe. So now we know what asset protection is for a sole proprietor. But let's go back to the taxes. Let's say that Joe's talking to his buddies and they tell him, hey you should form an LLC because it's going to save you a ton in taxes. Well let's go ahead and take a look at that. Okay so here's Joe's roofing as an LLC. So let's run the taxes through the process and see how it ends up. So Joe's roofing, $100,000 in net profit. Pays his self-employment tax of 15.3% if he gets a math deduction. He gets a 50% deduction, which is $12,446 after the deductions. He pays his federal tax rate of 22%, which is $22,000. Total tax of $34,446.55. Is this starting to look familiar? Joe gets to keep $65,553.45. There's absolutely no difference in taxes that Joe will pay being a sole proprietor versus an LLC. So really there's no tax benefit whatsoever becoming an LLC. However, let's go back to the roof example. So Joe does the roof on the house. Does the same lousy job that he did before. Joe gets sued for $400,000. He sues Joe for everything that Joe's worth. But Joe's roofing is only worth, let's say, $50,000. There's another $350,000 that needs to be collected. Can they get to Joe? The answer is no. They cannot get to Joe because there is a corporate veil that sits between Joe and Joe's roofing that will not allow that judgment to reach Joe. Now there is a caveat to that. If Joe does not maintain his books, if he does not have separate bank accounts, if he commingles funds, if he doesn't keep up his biannual reports, Joe could be in serious trouble and then he could get to Joe and that's called piercing the corporate veil where they can get to Joe's roofing and then they can get to Joe. So you want to make sure to maintain those corporate books, keep everything on the up and up, and then you can maintain that corporate veil in your LLC. So let's go back to talking about taxes. So now Joe is talking to his buddies again and they tell him, hey Joe, you ought to switch to an S-corp. It'll save you a ton in taxes. Well is that true? Let's go ahead and take a look. Okay so here we are as an S-corp. Same scenario, Joe's roofing, filing married, joint return. Let's point out here real quick that Joe, because he was an LLC and he became an S-corp, which is actually a tax designation, it's not actually a structure. So Joe is really still an LLC, he's just taxed now as an S-corp, but because of that he gets to maintain this corporate veil and keep that asset protection aspect. So let's talk about taxes again. So Joe's roofing has $100,000 in net profit. Now this chart looks a little bit different. So one of the things that's different here is Joe can now issue himself a salary. Now as a sole proprietor or an LLC, Joe cannot issue himself a W-2. He could issue employees W-2s, but any member or owner of an LLC or sole proprietor cannot issue themself a W-2. But as an S-corp, Joe issues himself a W-2. And for argument's sake, Joe gives himself $30,000 as a salary. Now Joe has to be careful when he's picking this salary. He has to make sure it's an industry standard salary for somebody that does the function that he does in this company. So he picks $30,000. Now at this point, Joe would normally be paying self-employment tax, but you don't have to pay self-employment tax as an S-corp. Now it's going to be FICA through a W-2. So in this example, the company would then pay half of the FICA tax. So Joe normally would have to pay 15.6%. But now because of the W-2, Joe just pays 7.65 and the company pays 7.65. So let's just pick the white arrow here and follow the company. So the company pays 7.65, which is half of the 15.6, which is $2,295. Now the company can actually record that amount as an expense on their books. So that's a kind of a benefit to Joe because before that was straight out of his pocket. So now if you come the other way, following the blue arrows, Joe would have to pay his half of the 7.65% of the $30,000, which is $2,295. Now you have to take the $30,000 and pay federal tax on it. So the federal income tax once again is 22%, which is $6,600. Plus you add in the $2,295 FICA tax and with a total of $8,895. So what happened to the other $70,000, right? Because the salary was just $30,000. Well now come to the light blue arrows. Right here, that is now considered a dividend and it doesn't have to pay the FICA tax. You get to avoid that altogether. So now that $70,000 in dividends passes through to the federal tax rate of 22%, which is $15,400. And then you add that together along with the $8,895 for a total tax of $24,295. So now Joe gets to keep $75,705. So let's go ahead and compare that to the LLC. So the LLC and the sole proprietorship got to keep $65,554.45. As an S Corp, Joe gets to keep $75,705. That's a $10,150.55 difference that Joe gets to keep. So that's a substantial amount of money and it's probably worthwhile that Joe switched. But there is another part. So the next part that Joe needs to pay attention to is his extra costs now that he switched to an S Corp. He's going to have to file for an 1120-S form. He's going to have to pay payroll and W-2 and 941 form processing fees to an accountant. Which for this example, let's just say it's $3,000 a year to have all those services done. So actually his total savings wasn't this number, it's this number down here which is a little bit smaller, $7,150. Now was it still worthwhile for Joe to switch? Absolutely. Yeah, for $7,150 that's money in Joe's pocket. So absolutely he should switch. Let's go ahead and look at another aspect of this. So this is the S Corp realities. The net savings with $100,000 in net profits, $7,000. Little bit higher than that, but let's just say roughly $7,000. So consider that what if you only made a $50,000 net profit or a $40,000 net profit. Well depending on your accounting fee, you might not make a profit at all. So you might consider not switching if your net profit is too low. Another thing that you could consider is if you did your own payroll and your own tax prep, then you could realize a profit sooner because you're not going to actually pay $3,000. You're going to pay significantly less. The one last thing to point out with an S Corp is make sure that you don't adjust your salary too low. A lot of people once they run the math will realize pretty quickly that they can save a substantial amount of money if they lower their salary. But if you do that, the IRS is watching and you will most likely get audited. So make sure that you leave that salary at an industry standard rate because an audit will not be worth all the headaches. So I hope that you found these examples pretty clear and have shown you the tax savings and asset protection provided by the different business structures and can hopefully help you decide which structures to pick for your small business and when to switch to other structures when your profits increase or when your risk increases. Honestly, as a roofing company, I would form an LLC right off the bat because your risk is fairly high. If you have any questions or comments, please leave them in the comment section below. And as always, please crush that like button, smash the subscribe button so you can continue to be notified whenever we put out the next video. Until then, please have a safe and profitable day.