Tldr: 87% of solopreneurs are paying too much in tax, simply because of one little-known “mistake” that nobody talks about
The good news? Once you’re done reading this, you’ll not only know if this is happening to you, but you’ll also know how to avoid this mess going forward
Thanks for stopping by and I don’t want to take up too much of your time today, but before getting into the good stuff, I did want to take a quick second and give you a brief overview of what you’re about to read.
For starters, it’s not something that’s based on theory or B.S., it’s actually something I’ve benefited from in my own business. Without getting into all the details now, let’s just say it all started a couple years ago when I was doing great in business, but wanted to find a way where I could make more money.
At the time I really couldn’t take on any more work, so I started looking around at different methods, eventually stumbled across a tax switch that instantly added $7K to my bottom line every year.
Yes, you read that correctly, one switch instantly added $7K to my bottom line every year.
And the crazy part of all this? A lot of other solopreneurs could benefit from this as well, yet very few do. Sure there’s a few reasons for this, but if anything, I think most of it boils down to simply being “unaware of the issue”.
The IRS certainly doesn’t go out of their way to tell us about this, and since most tax gurus like to target the “big fish”, we really don’t get their time/attention either.
But don’t worry, I’m here to fix that.
After noticing the results it’s provided for my business over the last couple of years, I decided to partner up with a tax expert who not only understands this process in full detail, but also gladly agreed to take some time and explain why it works.
After that, if you’re interested in having him help you, he’s left his contact information at the end. If not, no worries either. Worst case scenario, you’re aware of a tax issue that needs to be addressed in the near future. Best case scenario, you fix it today and save upwards of $13K.
Ready to jump in?
Great, here’s the tax expert I mentioned earlier, Brian Dela Cruz:
Thanks Sean. With an intro like that, I feel like I have a world of pressure on my shoulders now, so excuse me as I nervously shake at my desk, attempting to create the most exciting tax information you’ve ever read about.
All jokes aside though, I do want to also thank you for coming here today and if you stick with me for the next 10 (ish) minutes, I think you’ll be glad you did.
Seems like there’s not too many “life-changing” offers in place today, but if your income is at the right level and you’re willing to switch a few things, then we can easily help you save a lot of money right away.
Due to that, I really just wanted to take this time to “educate” on how the process works. From there, you’ll have everything you need to understand how it’d help you, and make an informed decision after that.
Needless to say, in typical “accountant” fashion, my first draft of this information was a little overboard. I went through and created (what I’d consider) the greatest whitepaper to ever hit the internet. I’m talking:
- IRS Codes
- Court rulings
- Previous revisions…
All things that’d be loved by my peers, but after having Sean look over it, he (tactfully) told me how it’d bore you to death. Because of that, we decided to switch things up and just tell you how it helped Sean’s situation, along with how that’d apply to your business. Said differently, relatable stories seem to be the best “education”, so let’s run through it this way:
How it helped Sean
In short, after being in business for a couple years, Sean finally had his “breakthrough” and reached the 6-figure mark. Excited was an understatement, as this was his main goal when he first started out, but then the tax bill came and decided to rain on his parade.
Not going to get into all his information here, but let’s just say that even though he was making a lot of money from a “revenue” standpoint, he didn’t feel like his take home pay was congruent with the additional earnings.
Just felt like he retained more as an employee making $80K a year, then he did as a consultant making $100K a year, so he started trying to figure out why this would be after that.
At first, he started off by going through his expenses. Wanted to see if he was sending more (as a percentage of income) in his new role, not necessarily the case. Everything seemed to match up, so he started looking at his taxes after that, quickly realized that his:
Effective tax rate was exponentially higher
If you’re not familiar with this term (effective tax rate), it’s essentially the formula of taking your total taxes, and dividing that number by your total income. This is what shows you the “true” amount of taxes you’ve paid, after calculating your:
And at the end of the day, is the only tax calculation you need to worry about. All other figures (i.e. tax brackets) don’t do much for you, so I advise just sticking to effective tax rate over anything else.
Needless to say, I will give him props for even doing this though, as 99% of people don’t even think to look at this figure. Truthfully, I like this is also the main reason why everybody blindly pays too much in tax, but that’s talk for a different time.
Back to Sean’s effective tax rate…
So after realizing how much extra he was paying now, which was nearly double what he was paying as an employee, he started to investigate. Honestly couldn’t see why it’d be worth it to work for himself at this point, as he was retaining more money as an employee (and having less stress while doing so), but he decided to see why this was before giving up completely.
Guess he found a few ways of saving tax after that, saving pennies here and there, but was never able to able to “move the needle” until he found the true root of his issues:
If you’re not familiar with self-employment tax, it’s a 15.3% tax that’s added on IN ADDITION to your income tax.
In other words, if your income tax rate is 40%, then your total tax rate would be 55.3%. Obviously numbers used for example purposes as it gets a little more complicated, but you get the hint. It’s an additional tax that really eats away at your profit, and since he hadn’t done anything to mitigate this tax, it was running wild.
Doesn’t take a mathematician to understand how big of difference 15.3% can make on your overall tax bill, and I’ll show you how to avoid this next, but I did want to take a quick second and mention that it’s not “completely” removable either.
Few reasons for this, but if anything, this tax is essentially the self-employed version of FICA tax. If you’re not familiar with FICA tax, it’s the additional tax employees pay on every paycheck they get, usually showing up as:
- Social security
All things we (theoretically) get back when we retire, just have to pay into now. All is great, and makes sense to most people, but the biggest difference between FICA and SE tax is that employees pay half of it (i.e. 7.65%).
The employer pays the other half, but since self-employed individuals are both business and employee, they’re liable for the full amount. Sure, there are some deductions that take place, but they’re really not material. That’s just getting into the weeds and focusing on pennies, not dollars, something I wanted to avoid on this report.
With that said, this is a huge reason why self-employed individuals always pay more in tax, but here’s the good news:
You can actually recharacterize some of your income (and save thousands because of it)
There’s a few ways I could explain this, but I’ve always been a “logic” guy. Really just like to understand why something works, so in the simplest terms, the IRS doesn’t think you should have to pay more SE tax than your employee counterparts (who pay in the form of FICA tax).
That’s what they say anyway, not sure if I fully believe it as you’d think they’d be more vocal about this if they truly felt that way, but that’s my personal opinion.
Anyway, due to this, you really just have to start off by figuring out what a “reasonable” salary is for your situation. This is something that can get a little difficult and I don’t advise doing it on your own, as there’s industry secrets you can use to pick the lowest amount possible and still avoid getting in trouble, but finding comparable salaries on Glassdoor is a good start.
To give you an example of this, let’s say you’re a web designer. From there, you’d go to Glassdoor, type in average web designer salary:
See that even though the average is $53K, the high is $74K. After that, it’d probably be a good idea to consider your:
But at the end of the day, $53K is probably going to be a safe start.
Now that we know this, the next thing you need to do is just look at your overall income. The key here is making sure your income is higher than your employee counterparts, as we can’t do much if it’s not, but for now we’ll say it’s $100K.
Not impossible to do as a freelance web designer, a figure most seem to achieve after a while, and one that gives us a $47K “excess” (i.e. amount above the average employee salary).
Because of that, this means that if you don’t proactively switch things up, then you’d be paying $7,191 (15.3% x $47,000) in unnecessary tax.
Starting to make sense?
Great, because even though it does get a little more complicated, that’s really all you need to know from an “estimated” standpoint. There’s actually a few other things you can do with this and save even more money, but let’s keep it simple for now. $7,191 is a good chunk of change as is.
Also, don’t worry, I know what question you want to ask right now:
“Sounds great, but what’s the catch?”
And I’m glad you did, because that brings me to the last main point:
As with everything else in life, there’s really no such thing as a perfect offer, but I certainly wouldn’t say this “downside” is as bad as others.
Could explain that in a few different ways, but for starters, let’s just say the IRS likes to start things off by putting us into “default” tax structures. Why they do this, I have no idea, but I think it has to do with simplicity.
It’s really not that hard to do “beginner” business tax at first, because even though you do have to learn a few new things, such as:
- Making estimated payments
- Keeping your books
- Filing a Schedule C
At the end of the day, it’s more of a headache than anything. Still haven’t found anybody who likes to do any of these things, but it’s a necessary evil we have to deal with.
On the other side of things, if you want to start taking advantage of the tax break that I’ve mentioned this far, then you do have to switch things up and start being taxed as a “real business”.
Gets complex so I’m not going to get into the nitty gritty right now, but let’s just say that instead of being paid as an owner who takes money whenever, you now switch things up and get paid as an employee of your own business.
A lot of additional benefits that come with this, such as:
- Being able to deduct health insurance premiums from your W-2 salary, allowing you to save EVEN more money on self-employment tax
- Giving you a little more wiggle room with retirement plans
- Unlocking other deductions that allow your tax bill to get even smaller
Pretty much everything that comes with being taxed as a “real business”, and no, just because you’re an LLC right now doesn’t mean you’re already there either. This seems to be another common misconception people have, where they think their legal entity (i.e. LLC) is the same as their tax entity, usually not the case. LLCs actually aren’t even a tax entity, reason why IRS has default tax structures for LLCs, something that’s not favorable if you’re making a good amount of money.
Anyway, that’s really the cause of all “downsides” that come with this approach, because being taxed as a “real business” comes with more responsibility.
Now, instead of worrying about the simple items I mentioned earlier, you also have to consider:
- Payroll tax filings
- Additional tax return at year end
All things that can get a little overwhelming for most, but here’s the good news:
You can actually pay somebody to do all this for you, and STILL make money because of it.
This is essentially the equivalent of getting paid to have somebody put more time back in your schedule, an offer that’s unheard of, and here’s a breakdown of how it’d look.
For starters, the most important part is just making sure you could actually get an ROI from the services, no matter what. For me personally, I never take on clients unless I know they’re going to AT LEAST receive a 1:1 breakeven effect.
In other words, if their total tax savings doesn’t (at least) pay for the additional expenses they’d incur, then I don’t help them switch. Doesn’t make sense to, but even if they do just breakeven, then I know it’s still a good option for them.
Financially, they’d see a net zero effect. Tax savings pay for themselves, but when you consider time saved, it’s a great benefit. This will differ depending on your situation, but according to multiple studies, the average entrepreneur spends 12 hours a month on their accounting needs.
Truthfully, I think a lot of this has to be back loaded as I see most people spend 80 hours doing “catchup” work in January, but I guess that doesn’t matter. Either way, they spend roughly 144 hours a year.
From there, let’s assume their time is worth $75/hr. Multiplying this by 144 means they spend roughly $10,800 on bookkeeping every year. I know, not quite the same effect as time ROI is different from financial ROI, but you still have to account for it. Funny things happen when you stop doing things you hate. Seems like mental energy 2x because of it.
Needless to say, in that scenario, they’d essentially be getting $10,800 in time back for free. No-brainer for anybody, but if you can scale it up a notch and actually start to see a profit from this switch?
Woofta, that’s where things get fun, and it’s really not that hard to do either. Going back to our example from earlier, in this case we saved $7,191 in self-employment tax alone. From there, assuming you hired somebody who provides the “CFO service”, meaning they do:
- Monthly payroll
- Monthly bookkeeping
- Monthly consulting (i.e. feedback on the books, via both financial and tax strategies)
Then they can easily add more savings on top of the $7,191 we just mentioned. In the spirit of transparency, a portion of everything does get mitigated by offsetting limitations, but the net effect is always greater.
In this scenario, we’ll say that you could save $9K each year (in tax), all for $500/month. That’s really all it costs to have this handled for you anymore, meaning you’d essentially trade $6K ($500/month) in return for $9K, and that’s before even thinking about the time savings side of things.
Heck, even if you only use half of your newfound hours to be productive, that’s still an extra $5,400 in the bank.
At the end of the day, I guess what I’m trying to say is that even though you do need to be making a certain amount of money before you can benefit from this, it can be extremely helpful once you do.
If you don’t, then you’re just paying unnecessary tax, and that brings me to:
In short, I really can’t give specific advice unless I understand your exact situation, so I’d like to take a few minutes and let you know how much money you could save by making this switch.
No obligation or anything either, and even if you don’t think you’re making enough money yet, that’s fine too. You’d be surprised with how easy it is to exceed above “reasonable salary”, and even if you haven’t reached that point yet, we can give some pointers on what to do once you reach that point.
In other words, you’ll at least have a north star now and in turn, know the exact moment when you should switch. That way you don’t waste one week paying excess self-employment tax, which is a sneaky siphon that you can never get back. Once they get their hands on the self employment tax, it’s theirs forever, which is exactly what I’d like to help you avoid.
Sound like something you’d like to hear more about? Taking advantage of this no-obligation offer that can either help you save money right away, or at least know when you should make the switch?
If so, all you need to do now is click on the link below:
See how much you can save
Fill out the short form, and we’ll be in touch within 48 hours (M-F) after that.
P.S. Don’t worry, we don’t even ask for your phone number right away either. Know how annoying that gets, so we’ll shoot you an email first, then see if you want to jump on a call (discussing the results) after that.
P.P.S. Also, only “requirement” is that you’re in the United States. Not sure how other tax laws work.