Understanding S-Corps to Save $ with Michelle Cook CPA (Re-Air)

What's the tea, friend? My name's Hunter Donia, industry business educator for hairstylists, but my friends just call me Hunty. Whether it be growing your clientele, making more money, or automating and streamlining your systems, in the next 20 minutes or so, you'll be hearing realistic, actionable strategies to create a beautiful career for yourself behind the chair. So, if you're ready to get into it, welcome to the Modern Hairstylist podcast.

Hello, my friend. Welcome back to the Modern Hairstylist podcast. Today, we're gonna be talking about some icky, scary shit, confusing shit that, uh, we did not sign up for, but guess what? It is a, um, it's a constant, it's a non-negotiable, and it's an absolute essential for you as a business owner, and we're gonna be talking about accounting and taxes and all that fun stuff today with my very great friend and my personal CPA, Miss Michelle Cook.

What's going on, Michelle? Hey, Hunter. Thanks so much for having me. Thank you so much for being here.

Would you mind giving, like, a mini introduction for us to tell the people who you are? Absolutely. Okay. Hi, I'm Michelle Cook.

I'm a licensed CPA, but before I was a licensed CPA, I actually went to beauty school myself. So, I graduated and was like, I have no idea what to do in terms of running a business or anything, and just 'cause I am me and probably a little bit more cautious than most hairstylists, I was like, "I've gotta go to university. I've gotta go take classes and figure things out," and so I did that. I ended up totally changing my plans, went and studied accounting, and then here I am back full circle, ready to help the beauty industry 'cause I get it.

I get how you graduate from beauty school, have no idea how to run a business, and all this money stuff is super overwhelming. It totally is overwhelming, and I'll be fully transparent and honest and say, like, I, I really pride myself in being s- like, somebody who can f- who, I'm scrappy. Like, I figure shit out. Like, I, I feel like I...

If I wanna learn about something and I wanna understand something inside and out, I'm gonna go and do so, and I'm gonna learn it. This is something, it is a never-ending, really difficult topic for me to fully understand inside and out. Like, it really, really is. And I'm really surprised, like, after owning a business...

I mean, it's not like I've owned my business for a crazy long time, but for as long as I have been dealing with this for a while now, I would have expected myself to have a pretty damn well-rounded knowledge about this and, and all of it, because that's just the type of person I am. But I don't, and there's so many layers that are uncovered to me all the time of things that I didn't even think about or things that I didn't even realize. And so I appreciate you so much for, um, for going back to your, your roots of, uh, of being a beauty school dropout, and coming and, uh, helping us in, in our industry, especially with this massive independent boom that we've had over the past two years, you know? There's a lot of people who never had to worry about this stuff before, like as a W-2 employee, and now they really have to be worrying about it, and we're all just figuring it out together, and thank you so much for being a leader and teaching us and, and, uh, assisting us in doing so.

Today, we, uh, decided to talk about a hard-hitting topic that I, again, will be vulnerable and share that I'm still don't even understand, and that's why you're here and that's why I have you do these things with me and for me. Um, we're gonna be talking about S-Corping, okay? We're gonna be talking about S-Corping, and we're probably gonna hit some misconceptions. We're gonna be, like, actually defining what this actually is and what the benefits are, if it's the right thing for you as a hairstylist, as a business owner, and I'm really hyped to dive into the topic.

H- so I literally, I literally... Me and Mis- Michelle is amazing and, and her, the services that she has right now are so elevated and fantastic if you do decide to work with your firm, Michelle. Your firm is fantastic, and, uh, we have these quarterly, like, CFO meetings, like one-on-one, right? And with one of your, your team members, and I didn't even realize that, like, I was doing, I was, I wasn't taking advantage of the fact that I was S Corp'd because I didn't understand this inside and out, and I was, like, messing with my payroll in a way where I was, like, completely depleting the entire point of me being an S Corp, and, and, and, and it, and I've been an S Corp for, like, a year now, and it took me that long to figure it out still.

So again, like, if you're listening to this and if this stuff completely goes over your head, I am there right with you, and I'm really excited to dive into it today. So Michelle, what the hell is an S Corp? I actually love how you called it S-Corping because I feel like I'm like, "I'm gonna use that now. That sounds so much more fun than, like, forming an S corp.

We're S-Corping now." An S corporation is not actually a legal entity. I always have to clarify that because people don't realize the actual business is usually an LLC or just a regular corporation. You have to register with your state to do that.

That's actually a legal thing, not an accounting thing. But once you have that in place and you're making enough profit where it makes sense, then you want to tell the IRS, "Hey, I wanna get taxed differently. Tax me as an S corporation instead of a sole proprietorship." And the whole point of an S corporation, like you brought up, is to save you in taxes.

The way that we save you in taxes is that you get paid in two ways as an S corporation owner. One is through payroll, and then the other is through owner draws that you get from the excess profit in your business. The tax savings 100% comes from the owner draw side of it because the payroll side of it is essentially equivalent to being taxed as a sole proprietorship. There's, there's no difference there.

So, anyways, we could dive into more and talk about how all that gets set up-But that's the situation, is the owner draws are your gold. Right. So, when you're on and, like, just, like, tell me to shut up and correct me if I'm wrong. When you are an S corp, right, you have to put yourself on payroll.

And so, that payroll is going to be, like, a consistent paycheck that you get, almost as if you were, like, an employee of your own business, right? Exactly. And you're getting... You're paying, like, payroll tax on that, or whatever it may be, and you're getting taxed on the paycheck that you're getting.

And then, on top of that, you can take your own owner's draw out of your bank account, like, as you normally would, if you weren't running a payroll or a paycheck to yourself through a payroll system, right? Exactly. Gorgeous. Am I getting taxed on my owner's draw?

You are. It's just taxed differently. Okay. Think of a really, really big corporation.

Like, they're listed on the stock market. You can buy some of their stock, and you might get some dividends from buying their stock. It's like that, except for it's just put into a little tiny box of a small business. And so what's happening is, in a huge corporation, the person who owns it, are they in the offices?

Probably not. They're probably out on a yacht somewhere, if they own a huge corporation. And we all hope to maybe be that person someday. But for now, we're still working in our businesses, and that's what's going on with the S corp, is basically, the IRS is saying, "You really wear two hats."

You are an employee of the business, working on it, getting it running, and then you're also an investor in the business. And so, you can essentially be pulling out these, quote-unquote, "owner draws." We call them... The technical word is distributions, but it's kind of like a dividend.

Like, y- it's the extra off of the top that you get from owning the business, not from actually doing the work. And so that's why you have to value the services that you're providing your business. So, if you were to, like, take you out and hire an employee to do that task, how much would you have to pay that person? And that's how we determine what the payroll is.

When you issue payroll, there are payroll taxes. And you... As a W-2 employee, you see those, Social Security, Medicare, the FICA taxes. What you don't realize when you're an employee is that you only pay 50% of those, and your employer actually pays the other 50%.

But when you're self-employed, you have to pay 100% of those, and that's called self-employment tax, and that's what you see on a regular sole proprietorship, single-owner LLC-type tax return. Once we move over into the S corporation, we basically split the profit of the business into two pieces. One is, okay, this is what the owner is actually doing for the business, in terms of pro- providing services, and that's gonna be subject to all the payroll taxes. But then all the extra profit that's coming just from, like, basically being an investor in the business, those don't need to be subject to those payroll, extra payroll taxes.

And it's a huge savings. It's 15.3%. Payroll taxes are- are big.

Yeah, that's a lot. Okay, that totally makes sense. And so then, so then I... So then it's, uh, uh, called a reasonable salary, right?

Like, that's what they call it? So then how does one determine, like, what their reasonable salary is for their payroll? And then also, like, if their reasonable salary, right, is all they could pay themselves, right, then does S corping even make sense? Oh, wait.

Yeah. Amazing question. So, there's a whole process of going through and figuring out how to pay yourself. One misconception that people have, um, when I'm having a conversation with them about making an S corporation election, is they go, "Oh, this sounds so much easier than what I've been doing, 'cause figuring out owner draws is, you know, really complicated and overwhelming.

And now, if I can just pay myself as an employee, I don't have to pay estimated taxes." And actually, none of that is true. Being an S corporation is not easier, um, and we can dive into that stuff in a minute. But in terms of figuring out that reasonable salary, or, um, if you wanna google, the SEO term that's gonna bring up a bunch of stuff is gonna be reasonable compensation.

And there are different factors to it. So, one is, how much time are you spending in your business? 'Cause there's gonna be a difference between a stylist who's working two days a week behind the chair and is gotten to the point where they've really scaled and they're making a lot of money only working a couple days a week, versus someone who's working a full 40-hour week, because obviously it's a lot cheaper to hire someone part-time than it is to hire them full-time. So, hours in the business is a big one.

Then we're gonna look at where you live, because obviously, the pay of someone in San Francisco is a lot more than Topeka, Kansas, and so we've gotta figure that out. Then we look at, what are you actually doing? And the reason why we do is because you know, as a business owner, you're not just behind the chair. You're doing so many other things, and so we wanna give you credit for all of the things that you're doing.

Sometimes you're the receptionist. Sometimes you're the janitor. Sometimes you're the marketing coordinator. You're all of the things, especially if you're an independent.

And so, we give you credit where credit is due for all of those things. We look at the mix. And then we look at what we call proficiency, which is essentially, how good are you at this thing? And so, I always say, "You don't want to let ego get in the way."

Because if you're doing your own bookkeeping, you're comparing yourself not to all the other hairstylists who are doing their own bookkeeping. You're comparing yourself to someone who has a degree in accounting and knows what they're doing in their bookkeeping. So, that helps though, because we actually want your salary to be as low as reasonably possible, so we can put, like, "Oh, I'm a really crappy bookkeeper. Okay, good."

And so, as we could get your salary lower, 'cause your proficiency is lower on those things that you don't have a degree in those things, and it's maybe not your jam, that provides you a lower salary. So, that's kind of the general process that you go through to figure it out. What you really don't want to do is just kinda, like, put your finger to the wind and be like, "Ooh, I feel like $40,000 feels good." That's it.

Okay, that totally makes sense. And so, then my second question is then, like, if somebody can't pay themselves more than what that reasonable salary actually comes to be, then does it make sense to S corp them? Let me give you the magic number, I feel. You want at least a $20,000 gap between your suggested payroll and the total profit of your business.

So, if you have a $50,000 profit and your payroll comes back as being at $30,000, you're good. Make that S corporation election. If you're at $30,000 and it's only a $40,000 profit, there's not really going to be a lot of benefit. It's not that you would lose money being an S corporation at that point, but there are extra costs to running an S corporation.

And so, then what happens is that all of the tax savings is eaten up by the extra costs. So, you wanna make sure that you're coming out ahead and you're winning by making the election. Thank you. That makes sense.

Okay, so then, is filing as an S corp, or like declaring yourself an S- an S corp, like, at the very beginning, is that something that, like, somebody could easily do themselves, or is that something where they would want the help of a professional such as yourself? I would only recommend doing an S corporation election if you're positive of your numbers. So, that's why I would be a little bit hesitant for someone to just, like, form their LLC and then like, "Yeah, I'm gonna be an S corporation election today," because if you're brand new in the business, you don't really know what your numbers are going to be. But I do recommend getting that LLC set up immediately, because then you have the legal structures in place.

As far as timing of making that election, you're supposed to file a timely election within 75 days of that LLC being created, or within 75 days of the new year starting, because you can always make an S corporation election later on if you don't do it right when you open up your LLC. But here's the beauty. There's an opportunity to do something called a late election if you qualify to do that, and I think that's probably a safer route to go if you're brand new in business. And just see where your profits are taking you, and then make that late election.

I will say, you have to use a little bit of caution in that, because to make a late election, you have to actually be operating as if you were an S corporation, which means you have to have owner payroll. So, let's say I open up in January. By June, I'm pretty positive that I have the profit that I should definitely be an S corporation. I'd wanna get that payroll set up immediately and get myself paid out, because that reasonable compensation number we were talking about earlier, if it's $30,000 a year, well, you're already to June, and now you only have, like, six months to get $30,000 paid out, because you have to get that reasonable comp paid within that year.

And what happens, the real big problem is people will wait until January of the next year, and then they'll go, "Oh, hey, look, I just made so much. I'm so proud of myself. I should definitely be an S corp." And then it's like, "Ooh, my friend, you didn't have owner payroll, and so now we can't really be making a late election for you, because that's just a red flag for an audit."

Okay, to sum it up, like, there's three ways to go about it. Like, let's say that you're a sole prop right now and you haven't LLC'd yet. So, like, when you LLC, like, within the first 75 days, you can also elect to do an S corp, like, within that first 75 days, right? Yes, once the LLC is formed.

Just to be clear, you cannot S corp as a sole prop. Right. And then the second one is just, like, within that, like, normal time period, like, beginning of the year situation, or like, before the beginning of the year? Yeah, usually by March 15th.

Like, if I, for this year, wanted to make an election, I would just need to file the paperwork by March 15th of this year- Okay. for a timely election. And then, of course, like I said, there's options for late elections as well. And then there's options for late election.

Okay, cool. Good to know. Good to know. What do you think there are misconstr- I know we already c- covered a little bit of them, but if there's any others that you can think of, what do you think there are, as far as misconceptions of what an S corp actually is and what it can do for you and what it does not do for you?

Yeah, I kinda mentioned this earlier, that people think it's going to be easier, and it's not. It's one of those things that... And that's why I say you really want that $20,000 buffer between your profit and then reasonable comp, because it is more work. And so, it's gotta be worth it to do all of the extra stuff.

So, one thing is, you actually have to have clean bookkeeping. It matters so much more than when you're a sole prop. There is a lot more detail that is requested within an S corporation tax return than there is with the sole proprietorship tax return, and they're just a lot more complicated. So, when people say, "Can I file the election on my own?"

I'm actually not so worried with people filing the election on their own. It's a very simple form. Name, address, when was the business created, what state are you in, and basically you sign it and put how many shares are in the business, if you're filing timely. If there's a late election, then you need to put a legitimate reason why there's a late election going on.

But it's- it's really a pretty quick form that I think a lot of people could easily figure out. My concern is actually filing the return, because those returns are not simple, and I would never recommend someone DIY those versus...For the right person, I actually say you probably could DIY a sole prop tax return. They're not that complicated.

So then, considering that, would you say, like, if you're not in a space where you are ready to hire somebody to help you with your bookkeeping and your tax filing, then maybe S corp-ing, as I like to call it, is not the best decision for you? I think that's a really, a really solid point. Yeah. And, uh, when I was saying there's extra costs of owning an S corporation, they are basically the tax return and then the payroll processing.

So, you're looking at an extra, like, $1,500 to $2,000 a year to run an S corporation. And I'll be honest, like, sometimes I'll get on discovery calls with people, and they'll be, like, pissed about, like, how much it costs. And I totally, I, I get that, especially, I think we're all feeling, like, the effects of inflation, and we're all getting very conscious about how we're spending our money and just wanting to make sure that we're truly getting the value of what we're paying for things. It's not that we don't wanna buy stuff.

We all love buying stuff. Okay. We just wanna make sure that we're getting the value for it. Right.

Exactly. And that's what I always try to explain. Okay, well, would you pay $2,000 to save $5,000? Right.

I would do that day in and day out. Absolutely. And that's what it comes down to, is, is the juice worth the squeeze? And that's what you gotta do.

Do that analysis to make sure it's worth it, and once it is, I'll, I'll make that bet every time. Totally, totally. That totally makes sense. I will say, in my own experience, because I have, because I have you and the firm, right, because I have my bookkeeping, and because I have you guys filing my taxes and things like that for me, I will say that it's been an easier process for me, because I love that Gusto just does everything for me.

Like, it's really nice. But, you know, I'm also in a space where I'm hiring employees, and that, and, like, Gusto has made that very, very easy, like, extremely easy, especially because I have out-of-state employees, right? But even for myself, too, even just by myself, I just feel like it's been, like, it has been nice. But it's not like, I, I still have to figure out my owner's draw, you know?

Like, I still have to figure that out at the end of the day, right? And, but, like I said, because I have you guys, it definitely does make it a little easier, right? Like, it's not, like, a crazy, over-complicated process, for me, at least, in my own experience. Yeah.

Sometimes people think, "Well, maybe I'll just, like, adjust my payroll up, and that makes it easier, 'cause it's automatically getting paid direct deposited. I don't have to think about it. Taxes are withheld, easy-peasy." But then, like I said, then you don't have that gap between payroll and owner draws, and it's not effective.

I will say, one thing that kind of disappoints people is that they do still have to pay estimated taxes when they own an S corporation. And that's because you're still having all that extra profit beyond the owner draws. So, just make sure that you're still calculating those, paying those quarterly, and I know it's, it's not convenient to do that, but it's just not convenient being a business owner sometimes, and it's the reality. Yeah.

And, like, exactly what you said, that's what I, that's what I accidentally did. I wa- I raised my salary on my payroll because I was like, "Okay, well, this is just, like, easily, automatically, like, go into my bank account, and it'll be fine." But then I was like, oh, then, then I was, I met with you, and you were like, "Um, you don't wanna do that." I was like, "Duh."

Like, obviously, I don't wanna do that. That's, like, the whole point of me being an S corp. So, instead, I just have an automa- I mean, it's pretty easy to, like, set up an automatic transfer in your own bank account, you know, if you ha- if you have it all connected and stuff like that. So, like, I have an automatic transfer in my bank account for, like, my distributions, right?

And then Gusto takes care of my reasonable salary, and then, like, it's all good to go. It's all a- Y'all know I love me some automation, honey. My favorite thing. Right?

I don't necessarily have anything, any other questions, and I think that I've covered everything that I hear the most from hairstylists when I talk to them. Is there anything else that we, that you think that we should cover, uh, around S corps before we wrap this puppy up? You know, I would just add in one quick thing, which is that when you are a sole proprietorship or a single-owner LLC, you get a home office deduction and mileage deduction without having to do anything extra. It just, you just throw it on the tax return.

Once you own an S corporation, it's a more formal process. You need to set up, uh, basically a reimbursement policy with the company, and then the company needs to reimburse you for the business use of your home office and for the business use of your vehicle and things like that. So, just make sure that that's set up properly, because otherwise, you don't get those deductions quite so easily. It's, it's just a little bit more work.

That's fascinating. Thank you for sharing that. I will just share, too. So, as an S corp, right, like, you can, 'cause you're paying into unemployment and stuff like that o- uh, because you are being W-2ed.

Am I correct? Mm-hmm. So, let's say a pandemic happens again, right? Like, you can file for unemployment, like, with that r- you know, with that base reasonable salary, am I correct?

That's accurate, yeah. So, like, during the pandemic, I was not self-employed yet. Like, I was so grateful and so lucky, and I know that the m- like, a lot of people do not have this same privilege. But I was so grateful that I was able to file for unemployment because I was a W-2.

And so, maybe that's just maybe just another, like, little emergency benefit. I know it's probably n- ne- something that we never had to think about prior to the pandemic, right? But I mean, hey, as we've seen, anything can happen nowadays, you know what I mean? So, I think it's just another thing to note, something that I just noticed, you know, 'cause in the pandemic is literally when I went into my own suite.

And I didn't know if we were gonna be shut down again, and, and everything was up to me at that point, you know? Like, my entire income was up to me, and it, and, you know, I wasn't gonna get no government paycheck, right? Um, if I wanted to, like I was up until that point. And so, it was a little bit scary for me.

But then now that I have an S corp, right, if I was still, like, full time behind the chair and that was my main source of income, it would be, like, a nice li- little, tiny safety net for me in one way or another. Absolutely.Okay. So, it- that's it, Michelle.

You just spilled all the tea for us today, and I really, really appreciate it, and I love that we were able to dive really deep into this topic, and I would love to have you on again to dive deeper into other topics. Before we got on here, we were, like, talking about all these, like, really juicy topics that I would love to dive into way deeper with you, and I just really appreciate you coming on here. I really appreciate you, uh, being one of my friends. I appreciate you and your business and the services that you provide for us as a company.

It really, really, really makes such a massive difference. And I appreciate what you're doing for the industry. Tell us how people can work with you, how people can learn more, and all those good things. And tell us about your podcast that you just dropped as well too, please.

Yeah, so my Instagram handle is @smallbusinesscpa. That's a, a great way if you're just looking for some free, uh, good educational content. I drop a ton of gems over there. If you're interested in working with us one-on-one, our website address is cartercookcpas.

com. And yeah, I just launched the Perfectly Profitable Stylist podcast, and uh, hopefully we can drop more of these, uh, types of episodes there and get people really understanding the financial side of their business. Yeah, it's absolutely essential, and I'm super grateful that we have you to teach us and lead the way. It's been fantastic.

So, thank you so much, Michelle. Thank you so much, my friend, listening to the Modern Hair Stylist podcast. If you enjoyed this episode, I would really appreciate if you left a five-star review wherever you're listening to this. If you do have the chance to leave a quick little testimonial about your experience listening to the episode, or the Modern Hair Stylist podcast, I would really appreciate if you took just a moment of your time to leave that.

It helps us reach other beauty professionals just like you who are looking to revolutionize the industry, so I really appreciate that in advance. So much love to you. I'll see you in the next episode. Peace out, girl scout.

Bye-bye.

End of transcript. © 2024 Hunter Donia LLC.