Tax Planning – Pat Flynn Case Study

Tax Planning – Pat Flynn Case Study

No one can deny the importance of tax planning when it comes to wealth management. Taxes are the greatest consumer of wealth. Take for instance Pat Flynn. Pat Flynn is a well-known internet entrepreneur who posts his income report every month.  In 2009 Pat Flynn had a net income of $178,649. If Pat did no tax planning he would have paid approximately $48,250 in federal taxes.

 

Smart Passive Income
Profit & Loss
January through December 2009
TOTAL
Ordinary Income/Expense
Income
Affiliate Earnings 10,806.62
ehow Earnings 1,448.56
Google Adsense 16,456.25
Green Exam Academy 158,053.29
iphone Apps 9,346.00
Private Advertising 7,108.32
Total Income 203,219.04
Expense
Bookkeeper 50.00
Continuing Education 3,000.00
Formation of LLC 420.00
iphone Apps dev 6,000.00
legal fees 1,000.00
outsourcing seo 900.00
paypal fees 6,000.00
Tax prep 500.00
Voice talent 3,500.00
website design 3,200.00
Total Expense 24,570.00
Net Ordinary Income 178,649.04
Net Income 178,649.04

Pat Flynn formed is LLC in 2009 as seen from his monthly reports and the summary above.

As an LLC, he could choose to be taxed as a sole proprietor, corporation or s corporation.  Just by choosing the s corporation status he saves approximately $7,000 in taxes.

 

Planned number of owners 1
Required protection from personal liability Low
Net income for business $178,649
Owner’s share of income $178,649
Salary received from business $60,000
Owner’s other income subject to self-employment tax $0
Owner’s marginal tax rate 20%
State income tax rate on individual income 10.00%
State income tax rate on business income 8.00%
Sole Proprietorship S Corporation
Salary received No Yes
Salary amount 0                 60,000.00
Business tax return required None Form 1120S
Protection from personal liability Low High
Tax Liability
Total tax on individual income N/A $9,180.00
Total tax on business income $48,250.00 $32,035.24
Total tax on combined income $48,250.00 $41,215.24
I wife & child
Savings $7,034.76

Other ways Pat can reduce his tax liability are as follows:

Retirement contributions: Pat can defer income by contributing into a retirement plan. Here are some options that could help Pat:

SEP IRA: With the SEP IRS, Pat can contribute as much as 25% of his net self-employment income.  Pat will not need to fund this plan until he files his tax return.  This makes it very flexible for the internet entrepreneur whose income is quite unpredictable. The SEP IRA only allows employer contributions which means that if Pat should ever hire employees he will need to make the same percentage contributions.

401K for the sole owner:  the 401k will allow Pat to defer quite a significant amount of income. Set up fees are usually very low. What’s more if Pat needs money, he will be able to borrow against the funds in his plan.

A Simple IRA: If Pat hires employees, this will be a great option to help his employees plan for retirement while saving taxes and building wealth.  Contributions are tax deductible and investments income are tax deferred. However, Pat will be required to make a matching contribution for his employees. A Simple IRA must be set by October 1st   and employee contributions must be made by December 31st.

Individual Retirement Arrangements (IRA): Moreover, Pat could chose an individual retirement account and will have up to April 15th to contribute into this plan.

Being in the 28% tax bracket, every dollar in savings could potentially save him 28% in taxes. Some ways he can minimize taxes are:

  • Making charitable contributions,
  • Funding his children’s college education.
  • Taking advantage of the home office deduction.
    • The way to handle home office deduction is different for the sole proprietor when compared to the s-corporation. Documentation is very important if this deduction is taken.

Finally, Pat will also need to watch out for the alternative minimum tax. The more you make the more complex your tax situation is. The highest federal income tax rate is 39.6%. This does not include state taxes and other taxes required by various localities. If you do not plan for taxes, you could be spending more than you need.

Planning for taxes could be quite complicated which is why it is advisable to have a CPA by your side to help you. If you do not plan carefully, your tax bill can potentially take you to the cleaners.