| I once taught a graduate tax class about choosing | | | | nor the parent will pay any income or |
| between an LLC and an S corporation. Probably | | | | employment taxes. Total tax savings? $1500 to |
| for this reason, people frequently ask me about | | | | $2000 annually.The $5,000-a-year Tax Benefit: |
| which entity form they should chose. "Is an S | | | | Healthcare Reimbursement ArrangementsOne |
| corporation better than an LLC?" they ask. "What | | | | other uniquely powerful tax benefit for sole |
| about a C corporation?" others query.Options such | | | | proprietorships exists: Healthcare reimbursement |
| as S corporations, C corporations and LLCs can | | | | arrangements, or HRAs. A healthcare |
| be the right choice in certain cases. But the lowly | | | | reimbursement arrangement (also known as a |
| sole proprietorship-an entity you form | | | | IRC Section 105(b) plan) is an employer plan to |
| automatically merely by starting business-is often | | | | reimburse employees for medical costs, including |
| best for tax reasons. And here's why:The | | | | medical and dental insurance, deductibles, co-pay |
| $500-to-$1000-A-Year Tax Benefit: Easy | | | | amounts, and any other legitimate healthcare |
| ReturnsA sole proprietor reports his or her | | | | expense.Sole proprietors, partners in partnerships, |
| business profit to tax authorities on simple one- or | | | | and S corporation shareholder-employees can't |
| two-page form called Schedule C. For many sole | | | | participate in HRAs. But there's a loophole in the |
| proprietorships, in fact, all the IRS requires is a | | | | law: A sole proprietor's spouse can be covered. |
| crude listing of revenue and expenses. In | | | | And that coverage can include both the employee |
| comparison, a corporation tax return is at least | | | | and the employee's family. Even though the |
| eight pages in length-and the return (typically | | | | spouse-employee's family includes the sole |
| either an 1120 or 1120S form) can it can be much | | | | proprietor!What this means is that if your |
| larger if there's a bunch of complexity.Corporate | | | | proprietorship employs your spouse, the sole |
| tax returns, by the way, practically force you to | | | | proprietorship can establish an HRA that |
| use full-blown accounting software such as | | | | reimburses all or some huge portion of |
| QuickBooks.Now, admittedly, the "easy tax | | | | employee's family medical costs. The |
| return" may seem like a small point. But the extra | | | | reimbursement is a business deduction for both |
| work and complexity of a corporation return | | | | income tax and self-employment tax purposes. |
| doesn't just mean more hours... It probably means | | | | That double deductibility often saves big |
| you'll need to pay someone like me to do your | | | | taxes.Let's say that your family pays $9,000 a |
| return. That cost can be anywhere from a few | | | | year for health insurance and another $9,000 for |
| hundred to a several thousand dollars annually in | | | | uncovered medical expenses. Say a family |
| extra costs-costs that are over and above what | | | | member has an expensive long-term illness. Or |
| the return would cost if your business operated | | | | simply that you've got teenagers with big |
| as a sole proprietorship.The | | | | orthodontia bills.Because you're self-employed, you |
| $1500-to-$2,000-Per-Kid-Per-Year Tax Benefit: | | | | would get to use the $9,000 of health insurance |
| Hiring JuniorHere's another often-missed tax-saver | | | | costs as a business income tax deduction in most |
| unique to sole proprietorships. A sole proprietor | | | | cases anyway. (Self-employed individuals can write |
| can hire his or her minor children and not pay any | | | | off medical insurance if their business is profitable.) |
| payroll taxes. Other employees and employees of | | | | However, with an HRA, you'll also be able to use |
| corporations would trigger payroll taxes-typically | | | | the $9,000 of health insurance costs as a |
| of at least 7.65% of wages paid.In addition, the | | | | self-employment tax deduction. That saves you |
| earned income of minor children typically isn't | | | | roughly $1350 annually.In addition, you'll be able to |
| subject to federal income taxes if the child earns | | | | fully deduct the other $9,000 of uncovered |
| less than $5,000 a year because of the child's | | | | healthcare costs as both an income tax deduction |
| standard deduction.If your minor kids help out in | | | | and as a self-employment tax deduction. This |
| your business and the business is operated as a | | | | deductibility could easily save you another $1350 in |
| sole proprietorship, the family tax bill can drops by | | | | self-employment taxes and then another $2250 in |
| one to two thousand dollars annually for each child | | | | income taxes. Total savings: $4950 annually.A |
| employed.Here's how the math works: If you just | | | | quick caution: A HRA needs to be |
| keep your last $5,000 of sole proprietorship profit, | | | | nondiscriminatory, so you would have to provide it |
| you'll very likely pay roughly 15% in | | | | to all employees. Many sole proprietors, therefore, |
| self-employment taxes on the profits. So that's | | | | might want to offer a full reimbursement plan |
| roughly $750 of tax. You'll probably also pay at | | | | only if family members were the only employees. |
| least another $750 in income taxes and quite | | | | You should confer with a tax advisor, probably, if |
| possibly another $1250 in income taxes on the | | | | you want to set one of these plans up.LLC |
| profit you keep yourself.If you pay your teenager | | | | formation expert Stephen L. Nelson CPA has |
| that last $5,000 because they're actually doing | | | | written more than 150 books. His bestselling book |
| work for you-the payment needs to be | | | | is Quicken for Dummies, which sold more than |
| reasonable-neither the teenager nor the business | | | | 1,000,000 copies. |