February 23, 2022 Advisor News

Business Owners Are No Longer A Client Niche For Advisors

By Paul Feldman

By Kevin R. Clark

Even prior to the onset of the pandemic two years ago, a major trend had been emerging which transcends all demographics.

It is the side hustle, and the economic upheaval brought on by the pandemic has only expanded its prevalence. Self-employment was once reserved for full-time business owners but has progressively expanded to the entire workforce, and consultancy is now as much the domain of the recent graduate as the tenured executive.

Multiple anonymous surveys of corporate employees concluded that nearly half of full-time workers (roughly 70 million people) had a secondary source of income pre-COVID, and a recent survey by Zapier.com projects that nearly 60% of all employees are currently earning extra income on the side.

Given these facts, financial planners and advisors should take note: business owners and self-employed individuals are no longer a niche clientele. Wherever you are and whomever you serve, your current and prospective clients expect you to be their expert as they launch new ventures and find unique ways to boost their incomes. This knowledge is even more essential for my fellow next-gen advisors, as our Millennial and Gen Z peers have the highest rates of new business creation and side hustling.

To that end, here are a few essentials to start expanding your expertise in advising the self-employed:

Taxation on Business Income

Many side hustlers are accustomed to having their employer handle taxes through W-2 withholding. It’s important to make someone aware of their new tax obligations BEFORE they start a business or begin generating side income. Self-employment (SE) tax can increase the total federal tax rate on business earnings by 10% or more, and unlike with W-2 earnings, taxes on self-employed income aren’t automatically withheld.

This necessitates paying quarterly tax estimates to avoid an unwelcome balance due at tax time. You can become invaluable to your clients by doing these calculations for them as well as showing them how to submit payment for the amounts you suggest.

Limited Liability Companies (LLCs) and S-Corporation Elections

Contrary to popular belief, an LLC is not a tax treatment. It is rather a legal entity, established at the state level, which can be used to segregate business assets and cash flows from the business owner’s other personal finances. When done correctly, an LLC can insulate the business owner from creditor claims against the business extending to non-business assets.

It’s important to not only make this distinction with clients, but to advise them on the viability of establishing an LLC. States differ significantly on requirements and costs to start and maintain an LLC. Researching the process and knowing when it does and does not make sense to form an LLC can save your client time and money, further justifying what they are paying for your expertise.

When the LLC is warranted, it’s equally important to advise the client on how to avoid invalidating the legal protections of the LLC. Educate your client about not commingling personal and business assets and refraining from personal-to-business transactions which could deem the LLC an extension of the owner’s personal assets.

Similarly, for those clients aspiring to be full-time business owners, it helps to understand the client’s state tax law and interpret when it makes sense for the client to convert from default tax treatment to an S-Corporation.

The conversion comes with additional costs – primarily those associated with establishing a W-2 payroll for the business owner and filing additional S-Corporation tax returns – but it can yield significant tax savings for successful business owners by passing through a portion of their profits that do not incur the additional SE tax. Research and talk to other professionals about what circumstances would warrant exploring or opting to elect into S-Corp tax treatment.

Tax Deductions and Savings Strategies for Business Owners

The 2017 Tax Cuts and Jobs Act (TCJA) largely eliminated the ability for W-2 employees to deduct job-related expenses. Simultaneously, it introduced the Qualified Business Income (QBI) deduction for sole proprietors, partnerships and S-Corporations. Thus, current legislation incentivizes side hustling or operating a business, as these deductions on self-employed income can allow a shrewd business client the opportunity to both increase their gross earnings while reducing their effective tax rate.

Understanding the rules for deducting home office expenses, travel, auto mileage, business meals, among other expense categories, as well as options for depreciating and expensing business assets, will all help your client more accurately project their net earnings and tax liability throughout the year.

Self-employed income can also allow clients to save more aggressively towards their financial goals. Whereas W-2 employees typically only have two main options for tax-advantaged saving – their workplace’s retirement plan and a personal IRA – an individual who is self-employed has several other tax-advantaged options. These business owner plans can provide your client with higher limits on what they can save to tax-advantaged accounts and often carry fewer restrictions on how the client can invest their savings.

Become an expert on the various plans available – SEP, SIMPLE, Solo 401(k), and cash balance plans – and their respective rules to help your client smartly allocate extra savings and balance upfront deductions with potential tax-free growth. Or, if your client is relatively healthy and able to use a high-deductible health insurance plan, you might explore saving to a Health Savings Account (HSA). For 2022, the contribution limit for an individual HSA is $3,650.

In most states, your self-employed client could get a triple tax advantage of fully deducting that $3,650 contribution for 2022 taxes, aggressively investing the funds for growth tax-deferred, and eventually withdrawing the earnings tax-free for future medical expenses.

Kevin R. Clark, CFP®, CIMA®, EA is a Financial Advisor at Highview Advisor Group in Worthington, Ohio and the owner of Arch City Tax Services, LLC. He currently serves as the national FPA NexGen President.

FPA NexGen, a community of the Financial Planning Association® (FPA®), aims to provide support and collaboration for those professionals new to the financial planning profession. With more than 2,500 like-minded young professionals, members of FPA NexGen are ready to share their experiences and further the future of the financial planning profession. Learn more about our engaged community and join the conversation on Twitter.

Here are past NexGen columns:

Tech Tools For Today’s Young Advisor

Fintech’s Lesson For The Young Advisor: ‘The Only Way You Survive’

A Millennial Advisor Pays Tribute To Those Who Paved The Way

Five Professional Development Tips For NexGen Advisors

Want To Thrive During The Pandemic? Exhibit These Four Traits

A Different Recession For Young Advisors

Taking The Next Step With Client Relationships

How To Build And Maintain Meaningful Virtual Engagements

With Every Crisis Comes An Opportunity To Make A Difference

Invest In Yourself To Raise Your Stock As A Leader

A Twentysomething Advisor Shares Tips For Breaking Into The Biz