How Joe The Plumber makes $250,000+ (Vanity)

Me ^ | 10/16/2008 | Daus

[Daus]

Parden the vanity but the complete lack of understanding by the Media and the Obama campaign on how small business owners are taxed is driving me a bit nuts (as a small business owner myself).
You hear all the "There is NO WAY Joe the plumber is ever going to make $250,000 a year!" Or any plumber for that matter...

What people need to understand is that small business owners (small C Corp, S Corp and LLC) are going to be taxed on what they take home in their paycheck AND the money that the company itself makes during the year.

Why does that matter? Because the owner is being taxed this year for money he/she leaves in the company for next year and beyond. So you are taxed for money you never really get yours hands on.

For example. Joe goes into business. Hires 5 plumbers. Pays himself a tidy $125,000 a year (pretty good, and not high enough to trigger Obama's huge new taxes). "See! no problem", they say and that is where everyone stops the analysis. The trick is... The company itself goes on to take in revenue of $600,000/year. Joe's margins are good. Let's say 25%. That means the company is going to clear $150,000 for the year. Joe being a wise business owner in these times wants to keep that $150,000 in the business so he can make payroll come Jan 1 and then plan for expansion in the coming year (hire more people, buy more trucks, train his workers).

But guess what? Joe can't do that. The $150,000 the company nets goes right to his taxable income which is now reported as being $275,000 once it's combines with his take home pay for the year and he has to come up with the 35% (and going up under Obama) even though he doesn't have that other $150,000 in hand.

And oh yeah, the inflated income for Joe also means he is WAY over any threshold for the myriad of tax credits being bandied about, he can forget about that.

So what is Joe going to do? He's going to have to pull a large chuck of profit out of the business to pay his taxes for the year, reducing what he can do in the following year. All of which will be taxed at the highest possible rate. So there goes $50K of the $150K. If joe is smart he's going to keep $50K on the side for payroll/expenses/rainy day, and then if he is lucky he has $50K for expansion. Well maybe because before long he will have to make his quarterly estimated tax payments for next year... The beast has to be pre-paid ya know...

[GoLightly]

The $150,000 the company nets goes right to his taxable income which is now reported as being $275,000 once it's combines with his take home pay for the year and he has to come up with the 35% (and going up under Obama) even though he doesn't have that other $150,000 in hand.

With some forms of business, yes. For many other forms of corporations, the corporation is a different taxpayer & profit is automatically charged taxes at the corporate rate from dollar one.

A guy could have an income of $40 K for himself & a corporation that has $300K in profit. Much of that $300K in profit could be tied up in inventory, like food on the shelves at your local grocer. He may benefit some chump change at his personal income level with the Obama plan, but with a higher corporate rate it's gobbled up & then some.

[vetvetdoug]

My business grosses >$800K per year. I pay myself $56K per year and my partner gets the same. We have 12 employees that make a decent salary and the rest is spent on overhead. Obama, the brilliant, is going to kill me financially because WE gross >$250K/year. As it is now taxes, city, county, state and federal take a significant amount of our money. I don't know how much longer we can keep afloat in this business other than dropping our salaries and we have D.V.M. degrees.

[NetSurfer]

Same situation here. Haven't taken a paycheck lately, either. If Obama is elected (please God, no) the first thing I will do is lay people off. I'd imagine that most business owners would do the same thing, if they are able to.

Of course the Obamatrons think their jobs are safe under the new Messiah. HA!

[Daus]

With some forms of business, yes. For many other forms of corporations, the corporation is a different taxpayer & profit is automatically charged taxes at the corporate rate from dollar one.

Yes, if you a C Corp and sufficient revenue is generated from people other than yourself you can be taxed separately. S-Corp and LLC's I think are always on the hook for taxes personally (though I do not profess to be a tax accountant, just a pissed off LLC and S-Corp owner.) :)

[Daus]

If they give me $3000 for hiring people...

Is this actually in his plan? :)

[DogBarkTree]

`Joe the Plumber,' Obama Tax-Plan Critic, Owes Taxes (Update1)

http://www.bloomberg.com/apps/news?pid=20601087&sid=ak7GnW2GiKF4&refer=home

They dont care who they destroy.

[JackOfVA]

S-Corp and LLC's I think are always on the hook for taxes personally

That's the advantage of an S-corp. You avoid the double tax hit, as all the income is taxed as personal income, not corporate tax and then personal income when transferred to the owner. The S-corp was invented to fix the problem of small business owners being hit by the taxman twice when in a C corp.

Jack

[postoak]

I did NOT know that. But it isn’t going to matter to “the stupid voters” (my new choice of names for those previously known as “the undecided”. To them, anyone making $125,000 a year has too much money.

Joe’s answer should be to raise the price on his services — passing the tax on to all his customers who voted for Obama.

[meadsjn]

...the tax rules say that principle paid on the loan is not deductable.

That's true for a residential loan, but not for a business loan.

The principal and interest you pay on your loan are business expenses, and you can deduct them from your taxes as such. In order to take advantage of a tax deduction, you must report the total amount of the loan, and the assets and expenditures financed must be necessary to operating the business.

[Daus]

Joe’s answer should be to raise the price on his services —

Unfortunately, the most likely answer for Joe is to not buy the plumbing business, and free lance under the table for cash. Like a Soviet plumber. :)

[GoLightly]

Former part owner (only by marriage) of C Corp here & no, not a grocer. I'm not an accountant either, but played one in the early days of the company. We were a sole-proprietorship for the first 7 years in business. One of the hats that I wore involved filling out the Schedule C's, filing the 941s, the 940s & the W-3s, along with doing all of the bookkeeping needed to generate them.

In a C Corp, owner/manager is an employee, just like any other employee. Like I said earlier, the corporation is a separate taxpayer. Many of them aren't even on the same year as individuals, because they use a fiscal year that they had to declare with incorporation.

[Pan_Yan]

Many, many people are going to learn math very fast when they realize that the tax break that President Obama gave them does not quite make up for the salary they lost by being layed off.

[drangundsturm]

That's true for a residential loan, but not for a business loan.

I respectfully disagree. I have bought and sold several businesses both as stock and asset purchases and I've sat in meetings with $350 per hour tax attorneys educating me on these issues in excruciating detail (and I do mean excruciating). What you say is (usually) correct for a loan for materials or supplies for the business, but not the business itself.

If you buy a business in a stock transaction (without filing a 338(h)(10) election), it is not deductable at all, the sale price goes into your basis, there is no depreciation, and 100% of principal on the loan is paid with after-tax money.

If you buy a business as an asset purchase, then in the kind of business Joe has most of of the value of the business ends up being "goodwill" and any principle has to be depreciated over 15 years or more (if he has significant new equipment that could be depreciated faster but that usually is not the lion's share of the purchase price). Therefore, you can only deduct 1/15th of the asset value per year but typically business loans do not stretch out that long so you end up paying taxes on a good chunk of the principle.

I have done both kinds of transaction (stock and asset) and I have to manage my loan principle vs. taxes very carefully due to these factors.

[Daus]

Congrats! There has now officially been more intelligent discussion on this thread of the implications of Obama’s tax plan then all three debates combined. :)

[meadsjn]

Thanks. Always something new to learn.

[justa-hairyape]

There is a way to get around that problem. You simply do not end the year with a large amount of profit that is subject to taxation. Instead of retaining the profits for equipment he may purchase in the future, Joe needs to actually purchase that equipment. Then he can first year expense the entire amount spent on equipment. There is something that GWB did for small business owners that the general public is clueless about. He raised the amount you can first year expense out. That has actually helped the solvency of many small businesses. That solvency right now may be the backbone of our country, since large banks and credit based big businesses are struggling. That is what we have been doing for our incubator or micro businesses. We have been purchasing equipment and first year expensing it out. That way our taxation exposure is lowered and the assets of our businesses is increased. Hopefully in the futuree the businesses will be generating large enough profit margins so that we can afford to then take the hit via taxation as we expose more profits as cash gains.

[Daus]

Instead of retaining the profits for equipment he may purchase in the future, Joe needs to actually purchase that equipment. Then he can first year expense the entire amount spent on equipment.

I agree the changes GWB has made in this area have been great. As a tech company I understand there is a great deal of incentive to make those purchases in the current tax year. Apparently this one is getting even better, my accountant keeps reminding me that it's getting even more lenient to include purchases you 'commit' to make but are not actually executed (or something to that effect).

Though it does help, this tax break was put in to spur the economy not to neccessarily push business owners into making wise purchase decisions. As an owner myself you can feel the pull to make purchases before they are actually justified or needed just to get the tax benefit. It can be dangerous when all of sudden you find out you need that cash for payroll and the money is sitting over in the corner in the form of an idle machine you bought early for the tax benefit. :)

On balance, this one is a net benefit to business owners, it's once again the politicians manipulating the tax code to achieve an end goal.

[GoLightly]

Something that I learned on my daddy's knee. When incorporating, leave all physical assets in a sole-prop or partnership & lease it to the corp at a “fair market rate”.

As you said, equipment purchases are timed to the tax year. Which entity buys new equipment depends on which one will get the best tax benefit. Also, the corp can buy from or sell to the sole-prop.

Great care must be taken to prove you haven't pierced the corporate veil & all of your transactions, meaning they have to be done in a way that protects the corporation's interest. You do this by making sure you “pay” fair market value in all transactions.

[justa-hairyape]

You are correct, one must make their purchases wisely. Never throw good money after bad. In our example, we have made purchases of equipment we normally needed to lease ourselves every now and then or equipment we are now actually leasing out to others. So in the long run these purchases have increased our assets, lowered our operating costs and are now generating cash income via leasing. True our cash assets have taken a hit and if payroll is an issue you need to be more conservative with the purchases. We are however very solvent and should be generating decent amounts of cash next year. Could have been doing some of that this year if talking the economy into a recession had not become the best way for someone to win a campaign.

[justa-hairyape]

Thanks for the info on the corporation tactics. Will be dealing with that next year. I am actually in a position where one of my General Partnership Companies (50 %) is occasionally leasing equipment to my Sole Proprietorship Company. In fact, I talked my partner into buying the equipment out of the General Partnerships Gains because we could make money in the long run leasing it out. I can just imagine how complex things can get in the future when incorporation is done. And I do understand how the best way to avoid potential conflicts is to use Fair Market Values in all situations.