I’ll bet you have asked your accountant the same thing I have. “Isn’t there some way I can reduce my taxes?” I asked my accountant that for the first 15 years I was in business, and his answer was always the same: “Tom, you are doing everything that can be done.” Well, after you hear that for 15 years, you naturally assume that you really are doing all you can do.
About five years ago, a lightbulb went on after I met someone who was speaking at the same event I was. He is a CPA and lawyer.
That individual spoke to contractors for two full hours about increasing deductions, taking money out as dividends and rent, and how to maximize your Social Security benefits. He also talked about the three ways people get audited and how to avoid every one of them. During our three-day Basic Business Boot Camp, we shared enough of his tax tips to literally pay for the class many times over. During this month’s article, I want to touch on just two of the things he covered.
SET UP MULTIPLE CORPORATIONSLet’s begin by dreaming a bit. If you could create the perfect benefits package, what would it look like? Let’s start with the basics of health, vision, and dental coverage. But, like the guy on television says, “Don’t stop there!” Why not have the company pay for your children’s college education? Dues at your local country club? Or, just for fun, what about an annual two-week vacation to Hawaii - all expenses paid? Sounds good to me! How about you? I know what you are thinking: “Tom, I can’t do that, I would have to offer it to all my employees.” Guess what? You’re right. If you offer a benefit to one employee within your company, by law you have to offer it to all employees of the corporation.
The key phrase here is “offer to all employees of the corporation.” According to my new best friend, the accountant-lawyer, every contractor should have at least two legally setup corporations. Corporation No. 1 has all your employees in it. Corporation No. 2 just has you and your family in it. Again, corporations can have any kind of benefits program they wish as long as the benefits are offered to all employees. Corporation No. 2, with you and your family in it, can create its own benefits package.
How do you do it? It’s really quite simple. After both corporations are legally set up, Corporation No. 1 hires Corporation No. 2 to run its company. At the end of each month, Corporation No. 2 invoices Corporation No. 1 for consulting fees for running their company. Let’s say the invoice is for $15,000. The invoice is sent, the bill is paid, and the $15,000 is now in Corporation No. 2’s account. How’s that for an idea? All the benefits you can dream of just became tax deductible, saving you lots of money, depending on the tax bracket you are in.
MAXIMIZE SOCIAL SECURITY BENEFITSI realize there is some concern in this area. The concern being that Social Security, as we know it, may not even be around when you retire. Yes, that is possible but, for today, we must assume it will be there.
Do you know what the term “maxing out of Social Security” means? This year every individual will pay Social Security tax on the first $106,800 earned. The company also has to match the Social Security taxes for the individual up to the same $106,800. That means if an individual earned $107,800 for the year, neither the person nor the company would have to pay Social Security tax on the last $1,000 earned. If an individual exceeds the max for that year, that is called “maxing out.” Well, guess what? The maximum Social Security benefits amount changes each year. Previous years were significantly lower. Take a look at Figure 1 for the maximum Social Security benefits limits for past years.
Just to be clear, look at the chart. You will notice, for example, in 1989 the maximum amount on which one had to pay Social Security tax was $48,000.
NOW FOR THE GOOD PARTThe accountant-lawyer shared with the contractors in the room that if they maxed out eight times in their entire working career, they will be then eligible for maximum Social Security benefits. That means if, for example, I earned $65,000 in 1995, I maxed out that year. Perhaps I earned $70,000 in 1998, that means I maxed out that year also. When I have maxed out eight total times in my entire working career, I am then eligible for maximum Social Security benefits.
The obvious question to ask yourself is “How much did I earn in past years?” The answer is simple. Each year all of us receive a statement from the government, just prior to our birthday, showing how much total income we earned during every working year. Next time you get your statement, compare it to the chart on the right and see if you have maxed out a total of eight times. If you have, you are eligible for the maximum Social Security benefits. It will not matter how much more you pay in, it will not affect what you take out. You have hit the max!
Once you have maxed out eight times, and are then eligible for maximum Social Security benefits, you now want to take money out of your company as dividends or rent. Why? Because you pay no Social Security or Medicare taxes on money taken out of your company in this way. The combination of these two taxes is 7.65 percent.
If your total salary is $100,000 per year then perhaps you will take out $40,000 as dividends. That means you do not have to pay 7.65 percent on the $40,000. That means you reduce what you pay to Uncle Sam for Social Security and Medicare by $3,060.
$40,000 x 7.65% = $3,060
Now give some serious thought to the above two ideas in 2010. They can save you money for years to come.