Structuring income to avoid taxes seems like a jerk move to me. But a bigger reason is that as long as my income is over some threshold, I'm happy. Dealing with business minutia reduces my happiness, so I avoid doing it.
1. Personal experience: businesses and products don't always last. Your product that is pulling in great money might last, or it might not. You could be down to $100k next year, or 50k, or $0. Tech moves fast. You are almost certainly overpaying taxes significantly, say, $50k+ a year.
I've had a product that pulled in $100k a year for many years on autopilot, and it just died one year.
2. $50k a year could be invested and compounded annually for many many years. Life isn't about income, it's about net worth. Having a higher net worth is like borrowing years from the future. You don't need to (just) build income, you need to build up net worth and income from different sources.
That will allow you to build a new product, or just keep enjoying life once your income stream shuts down.
Maybe I'm a jerk for minimising my taxes, but I'd prefer more money in the bank now vs later.
Assuming he's deducting expenses, I'd love to hear the magic method that will save him $50k on taxes. Solo 401k is likely the biggest potential savings and that would save (defer actually) less than half that. At his income level, the S-corp salary/distributions split is either risky or not very big. Might save $5k-10k. Any more than that and you're really just asking for an audit.
I was basing that assumption off of what he wrote in a post above: "I pay about $1.5k/month for colocation and the amortized cost of hardware, and that's the major expense.". He's probably not claiming every deduction he can.
I'm not US based, but given he does everything himself there's no reason to assume he has everything optimised. Every country is different, but most tend to have similar tax concepts to some extent. I'm based in Belgium, and if I wouldn't optimise anything on $200k income, I'd be paying close to 50% tax. If you do, you can comfortably get away with legally only paying a fraction of that, say, 15-20%, if not less.
His easiest way to save on income tax would probably just be to sell his business / product, so that he can book a capital gain. Capital gains are taxed lower than income. But that isn't exactly an optimisation unless the difference is significant enough. Definitely worth doing if you don't see it growing much from this point though, or if you're bored with it. That capital (for a business doing $225k a year in profit, maybe $500-650k after tax?) can then be reinvested tomorrow in other assets generating capital income, i.e. stocks, which is preferred to income taxable at income tax rates.
I'm assuming this is sarcasm, but given you wrote "it's been a suspiciously long time since I've done anything at all" it's not actually horrible advice.
I thought for a while about this comment and I must say, I don't understand why you're so snarky here. The advice is actually not that bad.
The assumption is: A mostly unmaintained business has the risk of becoming obsolete rather quickly.
Better to have cash in the bank now than a potential income over the span of several years. Furthermore, tax-wise, it is cheaper to sell than to keep the business.
The question for every business is probably: Did the business reach its peak (under the current owner) and is it more feasible to sell right now or can it provide your above-a-certain-threshold income for several years to come?
The reduced tax rate for capital gains is merely a side effect, but could favor the decision to sell or not to sell in one direction or another.
Would you care to elaborate why the advice is so bad?
Because your hidden assumption is that business is worth having only if it is keeping you busy or that adding new features might prevent obsolescence.
What he has is something that hasn't been taking a lot of his time with a fairly stable customer base of people like me, who pay for the service because what is does is useful enough for me and not because somebody on the other side is working his ass off.
It is a widespread belief that you should add features to prevent users either getting bored with your service or to diversify into other groups. What is rarely appreciated is that new features are a cost that may drive current users away when they dilute a product. If you solve a problem well for a large enough group of people, it may be sensible to just step away from the keyboard.
Obsolescence is actually not the main problem. The problem is disruption: someone else comes along and offers a better product, or better value for money, or some combination of both.
It was a niche mobile app (one time sales) that plugged into something larger and the market just shifted into a different direction. Even if I would've kept working on it, it would've died.
Looking back, I probably lost $250-300k there that I could've gotten if I would've sold it.
avoiding taxes vs. running your business in a way that is fully legal that allows you to not be penalized for being self employed are two different things. For example, if you paid 30% (self employment tax, roughly) on 250k, you're paying $75k in taxes. If you set yourself up as an LLC filing as an S-corp which brings zero minutia with it beyond the setup, you could pay yourself a salary of, say, $80k, pay your $12k in taxes and the other $170k would be taxed at 15%, saving you roughly $37,000 in taxes. Putting $37k a year into a retirement account and investments wouldn't be so bad.
This is wrong on multiple levels. SE tax is 15.3%, not 30%, and 12.4% of that is social security, which is capped at 118k. Beyond that, you're just paying 2.9% Medicare (plus normal federal and state income taxes).
Assuming that $80k is a reasonable salary for a solopreneur business (which seems iffy to me and probably to the IRS), you're saving 15.3% on $38k (80k to 118k), then 2.9% above that. Your profit distributions are taxed at ordinary income rates, so zero difference there. So on $250k, you'd save about $9k total, in return for higher audit risk and slightly more hassle and expense in maintaining the S-corp. Not crazy to say that's not worth it for some people.
It's also not an option in some locales (NYC doesn't recognize s-corp and taxes them as corporations, negating any benefit).
Fair enough. I'm not an attorney or an accountant and the comparison of tax liability for self employment vs. LLC filing as an s-corp may or may not be significant. It really depends on each person's situation in terms of income, expenses, etc.
I hope you are at least contributing to a tax-deferred retirement account? A solo-401k is a very good option for solo entrepreneurs, and I'd be surprised if anyone considered it a bad thing to take advantage of.
