Welcome to 2020! As our team prepares to dive into 2019 tax return prep, I wanted to take a moment to share what we have learned since the Tax Cuts and Jobs Act went into effect in 2018.  Since 99% of clients are in the trucking industry, this post is focused on answering the following:
How does an S-Corp election lower my tax bill?
What accounting changes do I need to understand as an S-Corp officer?
What the heck is a DRAW?  Did you say DISTRIBUTION? Speak English, please!
What is a reasonable wage for 2020 as an Owner-Operator?
The Jones Tax way to maximize your tax savings.
How an S-Corp election lowers your taxes
Let’s avoid accounting jargon as much as possible.  If I explain everything from company structure to accounting methods to tax optimization, this would be a book. Send me a message if you’d like me to break down a topic in a future post.

The S-Corp election is made when you’re sick and tired of paying so much Self Employment (SE) tax.  SE tax funds your Social Security and Medicare benefits.  It is based on taxable income from your business when your business is either a sole proprietorship, partnership, or Single Member LLC (SMLLC).  Don’t confuse this with income tax, although both are added together on your tax return.  S-Corps do NOT lower your income tax.

Self-Employment tax is 15.3% of your taxable business income showing on your Schedule C.  Reducing this tax will reduce your future Social Security and (maybe even) Medicare benefits.  This is the same tax that shows on a W2, called FICA tax, but employers pay for half of your FICA tax if you’re an employee.  The freedom of being your own boss is incredible but comes at a cost that we need to understand.  If you want to maximize your Social Security benefits, the S-Corp election is not for you.  Congratulations! You’re done reading and can stop worrying if you’re missing out on the mysterious S-Corp business!

What’s the catch to converting to an S-Corp?
Uncle Sam wants you to continue funding our country’s Social Security and Medicare programs!  S-Corp “officers” (a fancy IRS word for “owner”) cannot take money from their business without paying themselves a “reasonable wage” as a W2 employee.  THAT is the catch: your W2 wages pay FICA tax, which makes Uncle Sam happy.  (Remember: FICA tax is the same as SE tax).

Since S-corp officers are both owners AND employees, let’s agree to consider FICA tax a 15.3% tax.

The catch: The IRS does not allow S-Corp officers to take distributions unless they’re paying themselves a reasonable W2 wage.

What the heck is a distribution?
Distributions (also called “draws”) happen when you either transfer cash from your company’s bank to your personal account OR when your business pays for personal items.  Wages paid through payroll are NOT a distribution because you paid FICA tax on those wages.

Distributions can be sneaky, so you want to be aware when your business pays for your personal life outside of payroll.  Remember, the IRS doesn’t allow distributions for S-Corp officers if reasonable wages haven’t been paid for the year.

Here are a few distributions that need to be tracked if your business is paying (or just pay with a personal bank or credit card):
Food.  Are you claiming per diem? If so, food and drink are PERSONAL expenses.
Income tax. S-Corps only pay for a portion of your payroll taxes.  Income tax, payroll withholding, and estimated taxes are all personal expenses.
Entertainment.  Netflix is excellent, but nobody has ever been paid for binge-watching The Office…not in the trucking industry.  Think “ordinary and necessary” when paying for expenses using business accounts.  If a portion of your Sirius radio subscription is used for education, allocate a part of this as a business expense and the other as a distribution (or reimburse yourself for the business expense through payroll and pay for this with your personal bank/credit card).
Uniforms.  Underwear and jeans are nice (and appropriate) but are a personal item.  Personal safety gear and logo-wear is always a business expense.  Keep this in mind when expensing clothing as uniforms.
I am dropping a lot of rules here to give you an idea of where the “line” is with business deductions.  When we prepare your tax returns, we aren’t auditing your purchases.  We’re always on your side to maximize your deductions, so let us know if you have questions about expenses I haven’t addressed above.

Reasonable Wage for Long-Haul Truckers in 2020
Oh boy, this is a big one, and I haven’t seen other accountants publishing updated information.
Let’s begin by understanding some factors used by the IRS to determine reasonable compensation:
Training and experience
Duties and responsibilities
Time and effort devoted to the business
Dividend (distribution) history
Payment to non-shareholder employees (if you have employees)
What comparable companies pay for similar services
Reasonable wage is the most common IRS target for S-Corps, and the calculation is subjective, meaning we need to make assumptions about ourselves to compare ourselves to the national market of truck drivers.  If we don’t document our reasoning for how much we pay ourselves, the IRS may not follow our logic and begin arguing the wage was too low.  Ouch!

We did some homework for you to compare what other trucking businesses are paying company drivers.  This may not fit you and your business exactly, so be sure to ask your accountant if you are unsure.  We made the following assumptions:
3-4 years of experience.
Driver performance “meets expectations.”
No employees report to you.
We visited Salary.com and obtained the following range of salaries as of December 26, 2019:

 

The above graph shows us that 50% of company drivers make $52,610 per year.  This doesn’t include per diem reimbursements, bonuses, or health insurance benefits.  Many accountants continue to recommend a $40,000 salary, which is outdated and won’t likely appear reasonable during an audit.  The chart shows us $40k is only made by the bottom 10% of W2 drivers.

You’re an owner-operator who would be considered an above-average driver.  If not, you won’t be in business for long.  I don’t think this means you need to pay yourself higher-than-average wages to be considered reasonable, but paying yourself below-average wages could be hard to argue.  Therefore, Jones Tax recommends setting a $52,000 salary for 2020 for all owner-operators taxed as an S-Corp.

Breaking it Down
Now that we’ve covered the basics for owner-operators taxed as an S-Corp, what’s the breakeven point for Schedule C drivers to make the S-Corp election in 2020?

Good question! Let’s assume you’re a DIY-type and don’t want Jones Tax to optimize your payroll to maximize your savings actively.  That means you’ll pay yourself $52,000 through payroll, and any profit above this will be taken as a non-payroll distribution.  This is safe but we are about to discover that it reduces the tax savings of the S-Corp election.  The following table shows how much Self-Employment tax you’d be saving if your equivalent Schedule C income is $120,000.

 

Let’s talk about this.  I know $120k is high (less than 3% of our clients posted taxable income like this in 2019).  We included all the new deductions included with the Tax Cuts and Jobs Act.  The critical takeaway from this is that team-driving spouses need to work REALLY with their accountant to confirm the S-Corp election is going to be worthwhile.

Discussing why the entry point for making the S-Corp election has increased from $80,000 to over $120,000 is beyond the scope of this article.  At least you can see that it isn’t as straight forward as it used to be and, in many cases, it is easier to skip the S-Corp election altogether.

The Jones Tax Way to Maximize your S-Corp Savings
This isn’t all bad news.  I have been working on a new payroll approach that complies with the IRS requirements for the company owners while keeping payroll wages BELOW the recommended $52,000 salary described above.  This system is NOT for a Do-It-Yourselfer and only makes sense if your personal living expenses are low.  Misapplying this scheme could result in 1) an IRS audit and 2) failing to prove to the IRS that you’re exempt from paying a reasonable wage to yourself as an S-Corp owner.

Our system focuses on reimbursing yourself for business expenses and carefully tracking your distributions/draws before paying payroll wages.  In some cases, our clients save thousands in FICA tax payments while making much less than our $120,000 income scenarios above.  Paying yourself zero wages is possible, but everyone will be different, and we recommend working closely with our team to determine if this system is appropriate for you.

Interested in learning more?  Send us a message at [email protected], and our team will be in touch to get started.