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S Corp + HRA

taxTired of paying out the nose in taxes?  These two changes to your corporate structure could save you over $2,500 in cash-flow this year.

So, what are they?

First, let’s talk compliance.  We are not tax advisors, we are not accountants and we are not CPA’s.  We are fellow business owners and entrepreneurs tired of paying tax just like you.  This is what we uncovered for ourselves as we investigated the legal, ethical and moral ways to reduce tax.  This is currently the structure with which we operate our businesses to save in tax.  This is merely a conversation starter for you and whoever is preparing your taxes.  Please investigate and do your own research to verify if what we are saying is true and of benefit to you.

Now, let’s get on with it.  The first is something that cost me tens of thousands of dollars until I figured this out.  After 3 years of getting bent over at tax time, I vowed, never again.  After asking my former CPA if setting up a corporation would save me anything in tax, he said no.

I wasn’t satisfied.  I went and met with several accountants and CPA’s.  There is a difference.  After several conversations, I figured out that being structured as self-employed was killing me in taxes.  My current accountant told me that being structured as self-employed is really only designed for people making $0-$11,000 annually.

Well, I was making well over that and tired of paying so much in tax.  So, what is the solution?  Changing your corporate structure from self-employed or an LLC to an S-Corp.  Does that sound daunting?  It’s not.  I had an LLC, but it wasn’t really helping me tax-wise because it is a pass-through entity and you are still taxed on 100% of what you make as well as the 15% self-employment tax rate.

I was able to keep my LLC from a legal entity standpoint, but now I file Form 8220 to file my federal and state tax return as an S-Corp.  Why is an S-Corp so powerful?

One simple word, “distributions.”  What is a distribution?  A distribution is income out of your business that is not charged the self-employment or payroll tax of 15%.  This may be confusing, so let’s look at this in real numbers:

Let’s say your gross income is $100,000 and you are self-employed, an LLC and/or LLC filing:

Self-Employed Single Filer

Gross Revenue – $100,000

Self Employment Tax (-$15,000)

Standard Deductions (-$30,000)

Federal Income Tax ($70,000)

  • ($0.00 – $9,275) at 10% ($9,275*.10) = $927.50
  • ($9,275-$37,650) at 15% ($28,375*.2) =$4,256.25
  • ($37,650-$70,000) at 25% ($32,350*.25) =$8,087.50

Total Federal Tax Liability (-$13,271.25)

State Income Tax in Iowa ($70,000)

  • ($0-$1,539) at 0.36% ($1,539*.0036) =$5.54
  • ($1,540 and $3,078) at .72% ($1,538*.0072) =$11.07
  • ($3,079 and $6,156) at 2.43% ($3,077*.0243) = $74.77
  • ($6,157 and $13,851) at 4.50% ($7,694*.045) = $346.23
  • ($13,852 and $23,085) at 6.12% ($9,233*.0612) = $572.44
  • ($23,086 and $30,780) at 6.48% ($7,694*.0648) = $498.57
  • ($30,781 and $46,170) at 6.8% ($15,389*.068) = $1,046.45
  • ($46,171 and $69,255) at 7.92% ($23,084*.0792) = $1,828.25
  • ($69,256 and above) at 8.98% ($744*.0898) = $66.81

Total State Income Tax Liability (-$4,450.13)

Total Tax Liability Self-Employed Filing Single Payer – $32,721.38

And now, the same figures but filing as an S-Corp:

Self-Employed Single Filer

Gross Revenue – $100,000

W-2 Wages – $50,000

Distributions – $20,000

Payroll Tax (-$7,500)

Standard Deductions (-$30,000)

Federal Income Tax ($70,000)

  • ($0.00 – $9,275) at 10%($9,275*.10) = $927.50
  • ($9,275-$37,650) at 15% ($28,375*.2) =$4,256.25
  • ($37,650-$70,000) at 25%($32,350*.25) =$8,087.50

Total Tax Liability S-Corp Filing Single Payer – ($25,221.38)

So, the Total Tax Savings from just changing the corporate structure would produce a tax savings of ($7,500).  Now let’s look if we combine this with strategy #2.

This is only half the recipe.  Now that you are a self-employed with no employees you can have a single member S-Corporation which allows you to establish an HRA.  What is an HRA?  It stands for Health Reimbursement Arrangement.

Who is an HRA for?

The HRA is available to small business owners that are classified as either sole proprietors, partnerships, or C or S Corporations. This plan is especially applicable to small business owners that can legitimately hire their spouse, yet it can also be applied in other situations.

How does it work?

Through an HRA, small business owners are able to take advantage of tremendous tax savings by deducting up to 100% of their family’s qualifying medical expenses as a business deduction. More often than not, small businesses only take the standard personal deduction for health insurance costs when filing taxes.  Using an HRA, the average client obtains over $4,500 in tax savings each year.

Like an H.S.A. (Health Savings Account), you have a limit or ceiling of how much you can deduct in medical expenses each year.  Unlike a H.S.A., and this is very important, you do not have to pre-fund an HRA.  You can deduct up to 50% of your W-2 wages shown above.  In our example, that was $50,000.  Meaning that you could deduct up to $25,000 in the current year.  The key is, you do not have to fund an account for $25,000 to take advantage of this.

You would pay your medical bills out of cash-flow and then claim them through an HRA Administrator and at the end of the year, the summary of expenses would be deducted from your taxes.  This is huge.  What this does is allows you to potentially raise your deductible on your health insurance plan reducing your premium as well, permitting you to have money in savings or assets to cover that amount.

Let’s look at an example now.

Self-Employed Single Filer
Gross Revenue – $100,000
Self Employment Tax (-$15,000)
Standard Deductions (-$30,000)
Federal Income Tax ($70,000)
  • ($0.00 – $9,275) at 10% ($9,275*.10) = $927.50
  • ($9,275-$37,650) at 15% ($28,375*.2) =$4,256.25
  • ($37,650-$70,000) at 25% ($32,350*.25) =$8,087.50
Total Federal Tax Liability (-$13,271.25)
State Income Tax in Iowa ($70,000)
  • ($0-$1,539) at 0.36% ($1,539*.0036) =$5.54
  •  ($1,540 and $3,078) at .72% ($1,538*.0072) =$11.07
  •  ($3,079 and $6,156) at 2.43% ($3,077*.0243) = $74.77
  •  ($6,157 and $13,851) at 4.50% ($7,694*.045) = $346.23
  •  ($13,852 and $23,085) at 6.12% ($9,233*.0612) = $572.44
  •  ($23,086 and $30,780) at 6.48% ($7,694*.0648) = $498.57
  •  ($30,781 and $46,170) at 6.8% ($15,389*.068) = $1,046.45
  •  ($46,171 and $69,255) at 7.92% ($23,084*.0792) = $1,828.25
  •  ($69,256 and above) at 8.98% ($744*.0898) = $66.81
Total State Income Tax Liability (-$4,450.13)
Total Tax Liability Self-Employed Filing Single Payer – $32,721.38
LLC-No HRA
Annual Health Insurance Premiums  ($9,000)
Annual Out of pocket expenses   ($0)
Federal & State Tax Rate**   x20%
Total Tax Savings $1,800
Self-Employed Single Filer
Gross Revenue – $100,000
W-2 Wages – $50,000
Distributions – $20,000
Payroll Tax (-$7,500)
Standard Deductions (-$36,500)
Federal Income Tax ($63,500)
  • ($0.00 – $9,275) at 10% ($9,275*.10) = $927.50
  • ($9,275-$37,650) at 15% ($28,375*.2) =$4,256.25
  • ($37,650-$63,500) at 25% ($25,850*.25) =$6,462.50
Total Federal Tax Liability (-$11,646.25)
State Income Tax in Iowa ($63,500)
  • ($0-$1,539) at 0.36% ($1,539*.0036) =$5.54
  •  ($1,540 and $3,078) at .72% ($1,538*.0072) =$11.07
  •  ($3,079 and $6,156) at 2.43% ($3,077*.0243) = $74.77
  •  ($6,157 and $13,851) at 4.50% ($7,694*.045) = $346.23
  •  ($13,852 and $23,085) at 6.12% ($9,233*.0612) = $572.44
  •  ($23,086 and $30,780) at 6.48% ($7,694*.0648) = $498.57
  •  ($30,781 and $46,170) at 6.8% ($15,389*.068) = $1,046.45
  •  ($46,171 and $63,500) at 7.92% ($*.0792) = $1,372.45
Total State Income Tax Liability (-$3,927.52)
Total Tax Liability S-Corp Filing Single Payer – ($23,073.77)
S-Corp w/ HRA
Annual Health Insurance Premiums  ($9,000)
Annual Out of pocket expenses   ($6,500)
Payroll, Federal & State Tax Rate**   x35.3%
Total Tax Savings $5,383.25
Total Tax Savings ($5,383.25-$1,800) = $3,583.25
Total Tax Savings S-Corp + HRA Change = $9,647.01
So, when you combine the tax savings plus the addition of an HRA, depending on your medical expenses and medical premiums in a given year, you are looking at potential savings of above $10,000 annually in cash-flow from these two structural changes.
We do advise given the strict requirements for HRA’s to use an HRA Administrator.  We have partnered with BASE® a business in Adel, IA.   BASE® creates the documentation necessary for qualified small business owners to deduct up to 100% of their family health insurance premiums* and non-reimbursed medical expenses as a business expense. The typical BASE® HRA client saves an average of over $4,500 in taxes annually.
BASE® specializes in Health Reimbursement Arrangements and makes sure that clients meet the requirements of the IRS, the Department of Labor, and ERISA.  Without this plan in place, business owners can deduct only a portion of health care expenses, often less than half of the typical family’s outlay.