I don't think there is. I wholeheartedly agree with the prior sentiment. Way too much of peoples lives are spent on shit that does not really matter. As a people we have overcomplicated the shit out of everything to such a degree it's disgusting. And it's all based on greed. Optimize this structure to pay the least tax, optimize your income into this and that so it magically makes more money. Meanwhile those without any real money can't take advantage of any of that kind of stuff. Yeah, really fair!
Not everyone subscribes to the financial bullshit the wealth class has created.
Do you agree with the premise that it would be incredible dumb and dangerous not to structure their business into a legal limited liability company?
Do you agree that the accounting and tax handling is best left to professionals because it can be complicated and because you trade a little bit of money for the peace of mind that you’re following the rules and more free time?
If you agree with those two points, then the act of paying out the profits as a dividend instead of a salary rolls out pretty much for free. Because it’s not some hard to set up tax avoidance construction, it’s the norm.
The fact of the matter is I'm not saying "don't use a professional". I'm against the very concept of how convoluted everything is in this world- and nearly everything is created in ways that benefit people who make up let's say the top 15% of earners.
I'm not oblivious to any of these things, I have an econ, accounting & M.S. finance degree. I have a CPA (never practiced).
And you know what? I see this shit all the time in my line of work. I've been lucky enough to do more of the technology/programming side of the industry I'm in so I don't kill myself on the meaningless garbage that the people I'm creating stuff for actually do.. but I see this shit all the time.
Structures or laws being set up constantly to avoid tax that your normal person has absolutely no way to use. Self employed people setting up S-Corps so they don't have to pay into social security because they will be rich enough they don't need it themselves so why pay into the system to help others. People in other countries setting up US structures so they can pay a lower tax rate here than their home country while they get to reap all the benefits. LLCs being set up in delaware so you don't have to pay state taxes when one could easily argue you operate there if anyone checked. People throwing money into dividend paying stocks just because of a low tax. Reducing long term capital gains to stupidly low tax levels.
I mean I can go on and on. Your average person GETS ALMOST NONE OF THESE BENEFITS.
I'm not saying all of the stuff is bad or not needed. But the vast majority is set up so people who already make way more than the average person don't have to pay their fair share.
So look- I'm more being general here. I'm not specifically talking about this case as much as I'm just bitching about how the world works. It just disgusts me at this point. What one calls "optimization", at this point in my life I call it taking advantage.
The tax code is structured the way it is for a reason. It’s not there to be exploited. It’s there to be followed. DF is a business and labor of love for the two owners. One which generates revenue and is clearly above board. There is nothing wrong with taking dividends as the business becomes more valuable rather than increasing salary. And it’s not some mega tax loophole for the wealthy. By any measure these two aren’t wealthy. It takes 30 min with an accountant it doesn't consume your life and waste time and sap energy to be on top of your books…
They don't have a lump 7MM sitting around and are most certainly not set for life. Someone else did the math and it comes out to 100k per person per year after taxes and fees. Do you want to reassess?
Dividends are not automatically treated as capital gains, but in this situation, its possible they would be considered "qualified". The company being formed in the US, the dividends being paid out to US share holders, and the shareholders holding the stock for at least 60 days (120 days in some circumstances).
This really only applies to C-Corps as well, and then you run into the Double Taxation of C-Corp income and pay a 21% tax rate at the corporation, then additional capital gains on the dividend income.
BUT dividends would be tax free up to around $80k of income (any income (salaries, 1099, etc., also assuming married), then they would be taxed at 15% - 25% above that, but do not forget, the corporation has already paid 21%.
So optimizing for qualified-dividend-only income requires a LOT of forethought, and either accepting a lower income (since the benefit maxes out at $80k total income), or paying 15-25% + 21% for a 36-46% tax rate on your dividends.
They'd also likely pay the corporate tax rate in that case, which is 21%. Tack on 20% for the highest cap gains bracket, and you're at 41% federal unless you can work your way out of it with some loophole (e.g. carried losses on the cap gains side, idk what on the corporate side). FICA caps at something like $150k, so they'd actually be paying more than the highest income bracket of 37%.
The really smart move (or evil move, depending how you see it) would have been to start the business within a Roth IRA. Then you'd just pay the 21% corporate tax rate.
Out of curiosity, are there tax options (specifically, retroactive ones) for this situation?
As near as I know: (1) they formed a company at some point in the past (S-corp?), (2) they did constant work per year, (3) they had some donations per year, (4) they suddenly had a large amount of revenue in 2022
I'm guessing they didn't fully account for their time/expenses in prior years.
If they didn't, are there options to go back and amend previous returns in amounts that would be meaningful? (Assuming they have proof, etc.)
S-Corp is not an efficient entity type for a windfall like this. It is a pass through entity, and cannot retain earnings year over year, for that you need a C-Corp.
That said, had they already had a C-Corp set up, then this income would be taxed at 21%, so after Steam fees and taxes, they would be sitting on around $3.3M (not counting publisher fees and any expenses that might arise). If they hold that money for 120 days, they can then do regular monthly dividend distributions of around $7k, and it would be considered tax free to their person (assuming married, and no other source of income), but keep in mind they already paid 21% taxes on it. Any amount above that would be taxed at 15% (then 20% at top tax bracket), so if they wanted $200k/yr, that would be a monthly dividend of around $17k, 7k of that is "tax free" then the other 10k would be taxed at 15%. But again, they pre-paid 21% taxes at the c-corp level, so 15% would actually be 36%, which is nearly top tax bracket already, and it was hit MUCH sooner than if you took a higher paid salary.
What you suggest is not a hack of the tax code. Close corporations are generally required to pay reasonable salaries to their owners (and more importantly, payroll taxes on those salaries) if the corporation's revenue is derived from the labor of its owners. Not doing this is the #1 reason that close corporations, and their owners get penalized by the IRS. From personal experience being brought in to put out these fires, the IRS might be willing to negotiate the size of the penalty, but penalties will be owed, as will back taxes on the tax deemed due, as well as interest on those back taxes. Generally, these close corporation owners will spend more on penalties and interest for a single tax year than they would save in 5 years from this scheme, and that doesn't include legal fees they paid for the audit.
There is no bright-line rule for what a "reasonable" salary is. For low six-figure amounts, the SS contribution threshold is usually considered a safe amount with the rest paid as a dividend, but for seven-figure amounts, different considerations apply. Indeed, at larger amounts, the IRS is actually opposed to close corporations using inflated salaries to reduce corporate income taxes (because salaries are deductible to the corporation but dividends are not).
So: owners would have paid their progressive rate on the XXXk of income received as salary (which is deductible to the corporation), at a likely 22-37% marginal rate, plus up to 12% state income tax rate, for a total of up to 49% including state taxes. The remaining income received as a dividend would be subject to a corporate tax rate of 21%, plus a personal tax rate of 20% (15% on the portion of the dividend income, if any, below the QD 20% rate threshold, which depends on how much of their income they chose to allocate as salary), plus 3.8% NIIT, or a 44.8% rate of federal tax before state taxes on the corporation and the owner are taken into account. Or in other words, usually worse than just taking all of the profits as a salary.
I think this would be difficult to do without tax fraud. You cant retroactively increase your salary to show you were owed more money for unpaid salary.
If they had money in a C-corp to start with, you could run it at a loss (actually paying the salary), and then carry forward those losses to offset the windfall.
With an S-corp, Each year the company ran a loss, they would receive a negative dividend which would adjust their annual earnings down.
