One of the most important decisions you will make as an Affiliate involves the structure of your business.
The way in which you legally structure your box (or boxes!) will have financial, tax, and liability ramifications, and each will impact your success.
As an Affiliate owner, the type of income you earn is considered by the IRS to be “ordinary income”.
In very basic terms this refers to such things as income from membership dues, salary, and tips. The IRS wants to tax that income by having you pay self-employment tax on any income you earn. That self-employment tax is actually several taxes rolled up in one (payroll tax, FICA, social security and Medicare tax), and, since 2010, has stood at a whopping 15.3 percent.
Oh, and you must pay income tax on top of that. Ouch.
photo credit: Lori Greig via photopin cc
Which is why it is important to structure your business properly. Through proper entity structuring there are ways to minimize the self-employment tax. For our purposes, let’s discuss two common solutions: (1) to set up a partnership with your spouse, or (2) to form an S corporation as the 100% owner.
(1) Partnership
By definition there needs to be at least two members in order for the entity to be a partnership. This is often setup as an LLC (limited liability company). For tax purposes, the active member of the LLC, (the one doing the day-to-day operations) owns 20% of the business and pays self-employment tax on his or her portion of the taxable income. The passive member, let’s say the spouse, owns 80% of the business, but does NOT pay self-employment tax on that taxable income.
(2) S Corporation
Some Affiliates prefer to establish their businesses as S corporations (or S corps), in which they own 100 percent of the business. Taxable income from an S corporation is not subject to self-employment tax. However, the S corp does require that the company have an officer, and that the officer receive a “reasonable wage”. In most cases, you, the gym owner, will be the officer, and your S corp will pay you (the officer) a W-2 wage. The S corp will need to file quarterly payroll returns. You, the business owner, WILL pay self-employment tax on the W-2 wage amount. How much of a wage do you pay yourself? There is no right answer for that. The situation for each Affiliate is unique. But in most cases, it is never 100% of the taxable income.
Both of these options have pros and cons, and you may find neither is best for YOU.
Unfortunately, there is no such thing as a one-size-fits-all tax strategy. As always, discuss all available options with your proactive CPA.
Guest post by: John D. Briggs, CPA.
John is a owner and tax specialist with Incite Tax, certified public accountants experienced in all matters of accounting and taxation, IRS problem resolution, estates and trusts, business formation, financial planning and investment, real estate and business sales. John also is responsible for all of 321GoProject’s accounting and taxes.