DaveWentzel.com            All Things Data

independent consulting

Prunes Analysis vs Fletcher's Castoria

Did you ever have somebody ask you:  

  • At what fragmentation level should I REORG vs REBUILD?
  • How many indexes should I have on my table?  
  • How often should I update my statistics?
  • Should I change my oil every 3000 miles or 5000?
  • What is the correct federal funds rate to ensure full employment and low inflation?  

I call these "Prunes Questions".  And I call the process of arriving at a satisfactory answer to these questions "Prunes Analysis".  I named this process after the famous Fletcher's Castoria commercial from the early '60's.  

Just like the commercial says...The problem with prunes is...if I'm constipated, is 3 enough?  Is 6 too many?  

This question haunted housewives and moms for years until the advent of Fletcher's Castoria in the mid 1800's.  Generally, the best laxative at the time was a good dose of prunes.  But how many do you eat?  If you don't eat enough, you're still constipated.  If you eat too many you'll have diarrhea.  

I know, lovely thought.  Fletcher's was supposed to eliminate this enigma.  You just give your kid the dose on the bottle and forget about it.  But of course, even with Castoria you might need to take a second and third dose.  

Where am I going with this?  People, especially IT people, like every question to have a firm (pun intended?) answer.  Given a choice between some prunes and a proper dose of Castoria, most people will take the Castoria every time.  People think of Castoria as the "known" and the prunes as the "unknown".  Known is viewed as being better.  

But not every problem has one "known" answer.  Sometimes "it depends" is a valid answer.  The questions I posited at the start of this post are examples of "prunes" questions.  Every person may have a slightly different answer and who is say who is right and who is wrong?  The answers are often difficult to prove.  In every case the "it depends" is referring to all of the variables that cannot be held constant.  

But most people hate being told "it depends" as the answer to their query.  They view the tergiversator (ambiguous respondent) as lacking knowledge or being standoffish.  But that's not always the case.  Answering "it depends" can be especially perilous if you are a consultant.  Clients like to know that their consultants have all of the answers.  

So, unless I'm trying to be purposefully equivocating, my stock answer to these types of questions is, "Is 3 enough? Is 6 too many?".   This answer makes the questioner stop and think.  I'll then give my answer/opinion, given the knowns, without having to say "it depends."  It's usually good for a chuckle too, especially if the questioner is a bit older.  

Independent Consulting Summary

Here is a quick summary of things I learned setting up my own entity for IT consulting.  This list is by no means complete.  As usual, consult your own experts before making any decisions on your own.  

Issue W2 1099 LLC (pass-through taxation) LLC (taxed as S Corp) S Corp C Corp
least headaches especially if you don't care for accounting
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your clients need to file a 1099, which may be risky for them  
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you have lots of legitimate business expenses that can shield you from SE tax  
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provides you with the "corporate veil" to shield your personal assets from liability    
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simplest entity to set up and disband    
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subject to "self-employment tax"  
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some of this can be "shielded" by paying a reasonable salary and taking the rest as distributions some of this can be "shielded" by paying a reasonable salary and taking the rest as distributions some of this can be "shielded" (but not as much as the other two options)
requires you to handle your own payroll and payroll taxes      
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subject to Estimated taxes  
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possibly not/can be handled via increased FIT withholding possibly not/can be handled via increased FIT withholding possibly not/can be handled via increased FIT withholding
gets you the most deductions for fringe benefits          
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requires its own tax return          
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Shields you from Personal Service Corporation designation      
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can deduct legitimate business expenses  
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can save the most SE tax on health ins premiums      
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life ins premiums are deductible      
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(maybe)
You can save SE and FIT by hiring your kids      
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SIMPLE IRAs can save you a ton of tax      
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Other posts in this series

SIMPLE IRAs

SIMPLE IRA

Use form 5304 or 5305 to set one up (the former allows your employees to pick a custodian, the latter does not...utlimately it really doesn't matter).  Employer contributions are deductible and employee contributions are excluded from gross income for FIT purposes (you are still going to pay FICA though).  Your plan must be in writing and must be communicated to employees.  Most providers will provide you with a master or prototype plan to get started.  I chose TD Ameritrade.  
 
Some advisers recommend going with SEP IRAs vs SIMPLE, but in my mind the additional paperwork doesn't make sense.  With a SEP IRA you can contribute the maximum amount of money tax-deferred.  This isn't appealing to me since I'm pretty much living paycheck to paycheck and can't afford to sock away a large portion of my income for retirement.  Here's a breakdown of SEP and SIMPLE differences:
 
  SEP IRA SIMPLE IRA
Employer Considerations A Simplified Employee Pension (SEP) IRA is for self-employed individuals and for use by small companies for qualified employees to receive employer contributions.  Employers may contribute up to 25% of an employee's compensation (capped at $245,000 or $49,000) per participant in 2010. For 2011, these limits remain unchanged.  

A Savings Incentive Match Plan for Employees (SIMPLE) IRA is an employer-run savings plan that features employee tax-deferred contributions and matching contributions by the employer. Employers with 100 or fewer eligible employees who did not maintain another retirement plan are eligible to establish a SIMPLE IRA.

Employer contributions are mandatory.  

The employer matches employee salary contributions dollar-for-dollar up to 3% of compensation (can be reduced to 1% in any two out of five years), or makes a non-elective contribution of 2% of compensation for all eligible employees (including those who decide not to contribute for themselves).

The compensation cap for determining employer contribution amounts is $245,000.

Employer contributions are tax deductible.  

Employee Considerations Employees may also make traditional contributions to their SEP-IRAs of $5,000 for 2010 and 2011. Workers age 50 and older may contribute a total of $6,000 each year for 2010 and 2011. Workers who make their maximum Traditional contribution to their SEP IRA may not contribute to another Traditional or Roth IRA for the same tax year.

Each eligible employee can decide whether or not to participate and how much to contribute.

Employees may contribute up to 100% of compensation or a maximum of $11,500 for 2010 and 2011. Participants age 50 and over may contribute up to $14,000 for tax year 2010 and 2011.

Other Goofy Considerations   Funds cannot be removed from the SIMPLE IRA until it has been established for at least two years. Withdrawals from a SIMPLE IRA after two years are still subject to federal income tax and/or a tax penalty.
Special Forms Requirements A copy of the employer's SEP plan document (e.g., 5305-SEP Plan Document) must be filed with the custodian.   A copy of the IRS Form 5305-SA, and either 5305-SIMPLE or 5304-SIMPLE, must be on file with the custodian.  

 

Hiring Your Family

This is the next post in my independent consulting series, specifically dealing with business expenses that might help reduce your taxable income.  

Life Insurance Premiums

Life insurance premiums are deductible by an S Corp, but not an LLC.  This is another reason I like using an S Corp.  Just ensure your S Corp pays your premiums and it becomes a expense for the business and a nice benefit for you.  The one caveat is the beneficiary of the policy cannot be the corporation.  

Health Insurance Premiums

This is really confusing.  So do you pay your premiums out of your own pocket, or does your S Corp?  If you pay them out of pocket then you can deduct them on Schedule A (below the line) with the 7.5% limitation.  

Home Office Deduction

Everyone seems to fear the home office deduction.  And there is good reason for this if you are a W2 employee.  However, for S Corp employee-owners this can be a great deduction without increasing your audit risk at all.  

Business Expenses

As a new IT contractor (see the other posts in this series) you should be acutely aware of what legitimate business expenses you might incur that can lower your tax bill. 

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