Tax Advisors Playbook: Moving Your Client From A LLC To A S-Corp

Tax professionals. In today's video, I'm going to help you identify when your client should convert from an LLC to an S corp, why they're going to convert to an S Corp and then how to carry it out and audit proof the process moving forward. I'm a registered CPA attorney, best selling author and have owned multiple tax and legal businesses. And this process of the S Corporation is the gold standard that we use every day helping our clients succeed and take advantage of the tax strategies. The problem is many accountants are far too conservative in this area or don't understand the strategy. And then we've got the problem of dealing with clients that won't listen to us or follow through with the process. But I'm going to help resolve all of these issues and help you carry out the number one tax strategy for operational businesses in America today. Why is this so cool? Because you're going to make more money as a tax advisor and build that advisory practice you dream of and your clients are going to be more happy. They're going to be satisfied with your services and be excited to sign up for your tax advisory practice year after year. Now what is an S Corporation? For some of you that are new to the game, we got to cover this. The S Corporation is an election. I can take an LLC and file form 8832, the entity selection form and the accompanying 2553 and select the date. I want my LLC to become an S Corp. Now the LLC remains the same with the state. It might be best produce llc. It's going to keep the same ein and the world still sees it as an LLC from the outside, but on the inside we've made this S election. And so now based on the date we select, we're going to be an S Corporation moving forward and have to file an 1,120s tax return. Now why would we do all this? This is going to be the the golden question we're going to answer next and unlock all the benefits of the S Corporation. Now some people may think you have to be an INC or a professional Corp PC or a PLLC or something like that in order to be an S Corporation. That doesn't matter. You can be an LLC in an S Corporation by using Form 8832. You're going to use that form to say eh, I would like to be an S Corp and file that form in conjunction with the 2553. So the S Corporation is not an entity filed with the state. It's an election to change the character of that entity with the IRS and the state taxing authority. And that's it. That's what an S corporation is. Now when do we pull the trigger with this? What is the indicator, the key indicator where we want to reach out to our clients and, or if we discover this with a client interview, bring up the S Corp conversation. The figure I like to use is $40,000 of net income in their LLC, 40 to 50, certainly by the time they hit 50,000 of net income. So example, say you've got a realtor as a client, they're bringing in 60 grand on a 1099. They may have $20,000 in write off their auto, home, office, cell phone, some computers, electronics, blah blah blah and you're going to see them netting around $40,000. Well if you run the self employment tax on that $40,000 and compare it as just a plain old LLC on a schedule C and throw it into an S corporation with reasonable comp, you're going to see savings that pays for the cost of the tax return and the payroll service. Two topics we're going to come to a little later and I will break down what I believe to be that reasonable comp. But, but the point is when a client asks 40 to $50,000 of net income, they are ready for that conversation. The scary part is I've had clients come in and go, well my CPA said I've got to be making 200 grand before we can talk about an S corp. Net, not gross, but net. I completely disagree with that. Now for some of you that disagree with me on this point, please hang tight. We're going to talk a little bit more about reasonable comp, my credentials and why I'm going to be recommending the S corporation. But the outset I wanted to answer the question of when. And that when is you see that net profit climbing for your client and it's going to exceed 50,000 before year end. Now why do we do this? The number one reason is to save on self employment tax. See if we normally just report their operations on a schedule C, that LLC schedule, single member LLC or even a 1065, we've got partners, maybe husband, wife, whatever in that LLC. We're going to be paying self employment tax on the first $168,000 and then Medicare on everything after that it starts to add up. And so by converting to an S corporation we're able to bifurcate the profit. We can take some of that profit and allocate it to payroll, pay our fair share of fica under reasonable comp. And then everything else falls out below as profit or pass through or K1. That's why we use the S Corporation first and foremost, because we want to take that income and separate it between FICA income and pass through income. The problem is a lot of accountants, sometimes old school or some that are a little too conservative. And I apologize, I may be calling out some of you here, but I want you to hear me out, is that we think reasonable comp used to be all the way up here and the threshold of when we convert to an S corporation, in my opinion, can be too far out there. We need to accelerate that process. Now this is a good point for me to make this little point. I have been a CPA now for over 24 years, an attorney for 23 years. I passed my CPA exam in law school that I worked for KPMG, the tax court, had my own tax practice for 15 years, and been a senior partner in my law firm since 2000. Now through that entire process, I have never had a client audited for taking too little reasonable comp. I have read every case on reasonable comp. I teach classes on reasonable comp. I teach CE and our 360 conference every six months. And on our Tax Pro certification program, which you're going to be amazed to hear about, I teach all of this as continuing education with classes certified by the IRS for enrolled agents and have written countless articles on this and multiple publications and never had a problem of paying too little reasonable comp. Please give me a chance to persuade you that the S Corporation strategy is overlooked and often not utilized enough by the average small business owner. Operational business. I can't tell you how many times and I've done my 10,000 consultations, how many times I've seen clients come in paying far too much in fica. And by simply making an S election on their llc, we save them thousands. Now why is this so important? Because when you make this election, you move to the other side of the table with your client. You're helping them solve a problem. You're helping them better live their American dream. You're helping them save taxes and use that money to pay off debt, pay medical bills, build wealth. You become their advocate, not their adversary. You become a real tax advisor and they will love you for life. This is the opportunity to start providing advisory services at the next level. And people, this is only one of so many strategies I teach in my Tax Pro program. And I have seen people turn to tears in meetings, in person, on ZOOM and in Workshops when they catch the vision of this strategy alone. I cannot emphasize this enough. The why to use an S Corp is absolutely critical for the success of a small business owner. And you get to be the one to deliver that good news. It's amazing. You know what's even more incredible? The s Corporation has 15 times less chance of an audit, 1500% less chance of an audit than an LLC. A single member LLC on a Schedule C is 15 times more likely to get audited than the S Corporation. You are reducing their chances of an audit by making this election, you are saving them taxes. By making the selection, you are becoming their advocate and their tax advisor by making this election. People, I'm here for you. I know the stress and pain you're under as a tax professional, stuck in compliance, trying to keep your clients happy, taking on way too many clients, working way too many hours, and frustrated by the process. The S Corporation makes you a hero. And it starts to allow you to transition your practice into an advisory practice, which we'll talk more about later. And. And I have so much to share with you. Okay, now let's get to the how. There's several steps in this process. The first thing is we've got to talk to the client about this. I want to talk a little bit about that relationship and how you present this. We've got to take the right actions to make the election, and then we've got to follow through the proper procedures. Payroll, the 1120s, choosing reasonable comp. Through these steps that I'm going to walk you through, you're going to know exactly what to do to be successful with this strategy. Now, talking with your client, I know this is scary for some of you, and you may not know where I'm coming from on this because I know you. The scary part is when you sit down with them and go, I think we need to make an S election and save some taxes here. And what you're afraid of is they're going to go, why didn't we do this sooner? Why didn't we do this a year ago? People, it is not malpractice to make a new tax strategy available to your clients. Whether you knew it or didn't know it, whether you could have implemented it earlier or not is irrelevant. It's a tax strategy. You want to present it and let them know you learned something new or that you have a new strategy that you'd like to present to them and that you're taking them to the next level and they will appreciate you. Do not worry about this issue, worry about doing the wrong thing moving forward. Now that you learn this, they will love you for this. They will appreciate it. For example, if my doctor called me up and said, hey Mark, I've got a new medication I want to introduce you to. I think it's going to help you out with your high blood pressure. I'd be like, great, sign me up. Where do I go to fill it? I'm not going to complain and go, well, why didn't you call me a year ago and tell me about this? I'm going to be grateful. He called me, had me come in and gave me a new prescription. Take the initiative to engage with your client. And when you present this strategy, I want you to couple it with a pitch. A pitch for advisory services, which is something I teach in my Tax Pro program on how to pitch, advisory, engage, price it and deliver it with over 80 strategies. This is just one of them. So this is going to unlock the opportunity to have a powerful conversation with your client. That's how you do this. You don't just willy nilly go, hey, I'm going to make you an S corp. No. Take advantage of the opportunity to be their hero. It's a huge opportunity to open the advisory relationship. Now the how of the paperwork is the freaking easy part. You guys know that. It's an 8832 and a 25 53. But let's talk through a few practicalities. Now if you go through my training and the program, we're going to get into more details about timing and a husband, wife, llc and if there's partners, and you maybe have seen my book here right behind me, the Tax and Legal Playbook. It's on Amazon. I can't count how many. 5 stars, legit second edition. Check it out. I back all this up in writing, people. This is the real deal. So a couple practical. If I have a client come in in the middle of the year and I can already see they're over that 50,000 threshold and the profits coming down the barrel, I'm going to say let's make a retroactive s election to January 1st of that year. That's okay. And I'm going to start payroll in third and fourth quarter, wrap up the year with the 941, the W2 1120s and K1. They're going to be fine. I can make that retroactive s election time during the year back to January 1st and not have any problem whatsoever. Now some accountants will worry about the 75 day rule where if I don't make my s selection by March 15, then I miss the window for the year. That. That's why when you file your 2553, you're going to include and reference rev rule 2013-30. Yep, got that right. I want to write that down and make sure I got it for you. So when you put that in the request for the retroactive s election, it's always granted. Now, I should say sometimes you'll get a letter back from there. What? And then you send it again. You're granted. So make sure that you get that S election back to the first of the year so you can capture the whole year savings. Now, a word of caution. I don't like making a retroactive s election after December 31st, because, remember, it's all predicated on the fact you're going to issue payroll from this new S corporation. And if I don't kick out a W2 and a941 at the end of the year, and then I try to do a retroactive. Retroactive S election, maybe in February or March, I've got problems. Now, I've missed the deadline to file the payroll. So this is an important opportunity for you this time of year to be reaching out to your clients in third and fourth quarter and making sure we're making that retroactive s election before the end of the year so we can knock out the payroll procedure. Now, as I said, there's a lot of other little issues that can arise. Partnerships, marriages, divorces, different income levels from different operational businesses. It's beyond the scope of this video to dive into all those details. I'm sure you can appreciate that I'm going to highly encourage you to start following me and my podcast, get my book and take advantage of a demo, learning about my Tax Pro advisory training. It's going to take you to a whole new level, trust me. And what do we call it? The Main Street Tax Pro certification. That will be actual credentials right behind the end of your name. And. And take your business to that tax advisory practice you've been wanting to build. All right, so you've made the selection, you've backdated the 2553, you had a conversation with your client, and now it's time to do payroll. Now we have to talk about reasonable comp. And this is why I have my little whiteboard here. Because what I created years ago, and I think it's taking the country by storm, is the Kohler payroll matrix. Now, let me write this up for you, and I want to walk you through how I approach reasonable comp. Now, here's what the rule is in concept. What the IRS Congress, under statute has said. If you have an S Corporation, you have to take reasonable compensation for the work you provide in the business based on the money you take out of the business. You should pay wages to yourself and pay your fair share of fica, Social Security, and Medicare. That's the concept that reasonable comp is supposed to be fair and regrettably, I think is wonderful. It's a subjective analysis. Some may argue it's based on the type of business, how much time you put in your age, how many employees you have, the region, in the country, la, la, la, la. And there's companies out there that will sell software to you and guarantee that this is the way you do it, based on blah, blah, blah. Well, even after interviewing multiple prior IRS agents that worked in the Chicago office on S corporations for years and doing this work myself, filing thousands of S Corporation tax returns over the last 20 years, I have found that there's an average approach to this that I've talked to so many IRS agents that say, hey, if you're in this range, it's not worth our time. Let's just be reasonable. I. E. Reasonable comp. So what I came up with is this matrix to help us find that balance, and we can be confident that we're going to generally be okay with our clients. And I've never had a client audited in this boundary on the x axis, we're going to put dollars, zero dollars, up to, let's say, $400,000. Now, this dollar is our profit. And in fact, I'm going to get a little more specific later. It's our draws. So I'm going to put profit, or draws on the Y axis. We're going to put the percentage of profit in payroll, so we're going to have zero percentage here up to 100% in payroll. So if I made $1,000, I might take $1,000 in payroll. So it's. That's right here. So what happens that's fascinating is my income goes up. This is the beauty of this. My payroll actually goes down as a percentage. So what's interesting, as my income goes up, my payroll goes down as a percentage and then levels out that it sounds counterintuitive, right? But let's look at an example here. Let's say my profit, or draws, is about 100 grand. And then we're looking over here at 20%, 30%, 40%, 50%. We're going up our scale here at about 100 grand. That's our sweet spot. I might be at about 40% in payroll. I got to clean this up a little bit. Now, this is printed in my books and countless articles, so you can go look at a prettier version. But we'll go 20, 30, 40, 50, yada yada. So at about 100 grand, I like to see a payroll allocation of about $40,000. That would be the W2 and then the K1 would be 60 grand. So we're going to take reasonable comp of 40% when our income is around 100 grand. Well, what's interesting is my payroll percentage probably clean up this line too. My payroll percentage starts to go down and I flatline it at about 20%. So I've have a client with 400 grand in profit or draws. I might take payroll of around 80 to $100,000. And some of you I know are freaking out right now going, oh my gosh, you're going to take 100 grand in payroll on $400,000 of profit? $300,000, K1, they're going to get audited. I haven't seen that. Have you seen that? Or is that just the myth, the fear that's out there? Never had a client audited in this realm. Now, you might ramp up the payroll if there's, you know, a situation that you subjectively feel it should be a little higher or ramp it down a little. But here's some interesting points. When I have a client that hasn't taken any draws at all and the 400,000 stayed in the business, there is a zero requirement for payroll. Now, an interesting point here is that this matrix is really not based on profit, it's based on draws. So if you have a client that made 400 grand and they didn't take out any money, no distributions at all, they put all the money back into the business. Do you know what their payroll requirement is? 0. Because they didn't take compensation, there is no reasonable component. Is that interesting? So 400 grand in profit, all put back in the business. Zero payments to shareholders. So what you're really Comparing is line 7 on page 1 to line 7 in the M2, because that you're looking at distributions to compensation, not profit. That's another misnomer. So we're going to be talking to our client throughout the year. Oh, you made 50 grand this year. How much did you actually take out? Nothing. We've been living off my spouse's day job. We're putting it all back in the business. Now you're going to explain phantom income. They're going to have a K1 with some income, but there may be no payroll requirement. See, these are some of the nuances that you're going to learn as you elevate your practice. So this payroll matrix in summary helps us find the right payroll. And I want always in this mix. Once my client makes about again 40 or 50 grand, we're going to switch from 5050 to 40 60. I don't know, might be 30, 70, you know, we're going to keep pushing down the payroll percentage and ramping up the pass through. That's the goal. All right, now with all that said, let me share a couple of examples because over 10,000 consults, I've seen it all and we're doing it every day here in our law office, helping clients around the country and alerting them to the strategy. So let's do kind of a basic one and then more of an advanced one. First one that's super common and I love this when I go speak at a realtor conference, a real estate conference of some sort. We've had it. There's a realtor a couple years ago getting brand new back into the business. She was just killing it, having a great time and she had netted about 100 grand, probably brought in 150. We were writing off everything, cell phone, travel, auto, some training, ya la la la. And, and she had netted $100,000 the year before. She paid at least $15,000, 0.153 in self employment tax. Well, we introduced the S Corporation. So let's convert that over that LLC that she already had, put her on salary of $40,000, kick out the $60,000 as pass through, let's go. She's like, all right, $10,000 in savings, that's a big deal. $10,000. When you're making 100 grand and you can add 10% to your bottom line, you're changing someone's life. Now another example was, boy, it was here in Arizona. It was a contractor that was doing home development. They had kind of a big crew and they, they'd been, you know, sucked into the LLC concept because a lot of investors and real estate developers think, oh, all I need is an llc. All I need is an llc. And they had this old school accountant that had been around forever and I think they literally forgot to just talk about the S Corporation. I don't know. But this client was netting 1.5 mil on a schedule C. Now I know some of you are like, well that's Obvious. Oh my gosh, that should have been an S corp. He wasn't and we see it all the time. So anyway, we put him on salary at 150, not a big deal. He had a whole management team, he was golfing one day a week, yada yada. We felt reasonable comp was fine at 131 50. When we finished that tax return, that first year savings of over $30,000 in FICA, you think that's a game changer? It was. And this is again not high risk. Now some of you may go, that's way too aggressive in salary. Fine, choose another number you're comfortable with. But you're going to save, you're going to save the client far more than the cost of doing the S Corp return. And for four quarters of payroll. That's all we're talking about here. Now one major hurdle in this process at the end of the day is clients think they have to put themselves on a W2 every two weeks. They're stressed about cash flow and all that. I'm a huge believer in after the tax payroll. So you meet with the client at the end of first quarter, might be right at the end of April, hopefully before then, but you've got through January, February, March, and you're going to be doing that first quarter payroll. You ask your client, how much did you take out, how much did you take in profit? And they go, oh, I took out $30,000 in profit. Okay, let's do payroll at 10, you pop it on the 941, you send it in, you're done. They don't need to take a paycheck along the way. You can just do your quarterly payroll after the fact and allocate a certain number on the 941 for what they should take in reasonable comp. Then at the end of the year, you finish out the rest of the payroll reports, kick out the W2 and you're off to the races. So after the fact, payroll also makes it easy on the client for them to keep just taking draws when they want. And then you're meeting with them quarterly in a tax advisory capacity to nail their payroll at the same time. Well, you like what you're hearing? I got more. I've got 70, 80 strategies in a 12 module certification program, weekly trainings, white paper, a dashboard with resources, community, a tribe of like minded professionals building tax advisory practices. I even have one of my favorites, module 13, which is how to build an advisory practice, how to bill it, how to engage the client, role playing. It's an amazing training and it's changing the industry. I need to challenge you to please, please click the link below and do a demo. Check it out. You will be absolutely blown away. It is affordable. It is continuing education. It includes two conferences a year online training that you can start immediately today. And the S Corporation strategy is just one of those tax strategies. If you want to become a tax advisor, you've got to learn the strategies to teach how to pitch tax advisory and be in a community of other tax advisors. I've got what you're looking for. Thank you so much for watching. I want to see at the next training, so click that link below and I'll see you next week.