In 1928 Evelyn Gregory was the 100% owner of United Mortgage Company. United Mortgage Company owned 1,000 shares of a Monitor Securities Corporation. To comply with the law of a tax-free corporate reorganization, Gregory created Averill Corp, transferred the 1,000 shares into Averill, dissolved Averill, distributed and sold the 1,000 shares for roughly $133,333 while avoiding $10,000 in tax.
Brilliant – in my opinion!
To the contrary, the Commissioner of Internal Revenue, Guy T. Helvering argued that there was no business reorganization and that Gregory had simply used legal forms to understate her tax liability by $10,000.
In 1932, upon review, the Board of Tax Appeals initially ruled in favor of Gregory allowing the tax-free organization.
In 1935, to Gregory’s dismay, both appellate courts of the Second Circuit and Supreme Court ruled Gregory v. Helvering
in favor of Helvering the IRS Commissioner.
Judge Learned Hand of the Second Circuit Court of Appeals, however, did make the following statement: “…a transaction… does not lose it’s immunity because it is actuated by a desire to avoid or evade taxation. Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose the pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”
I agree with Judge Hand – there is no reason to pay more tax than what we are legally obligated, and there are many tax strategies that we can use to make this happen.
That is why it’s important to learn how to earn passive income online and pay less tax – because it’s not about how much you make, it’s about how much you keep!
3 Types of Income
Before you can begin to deploy any type of tax strategy it’s important to understand the 3 different types of income that the IRS recognizes. This is an especially important step in the process because each of these different types of income is taxed differently.
The 3 types of income are:
Earned income is income that is produced in your normal day-to-day activities such as your job, W-2 wages, salaries, tips, small business, 1099 commissions, consulting, products, and many others. It is important to remember that the the production of earned income requires a substantial amount of participation from the individual – commonly referred to as “material participation”.
Portfolio income is income that is produced outside of your normal day-to-day activities and is not created through your normal business activity such as interest, dividends, and capital gains.
Passive income is income that is produced from an investment such as a rental property or a limited partnership in which you do not materially participate. According to the IRS, there are only two different kinds of passive income:
- Net rental income from real estate or equipment.
- Business income in which you do not materially participate.
Passive income does not require a substantial amount of participation from the individual.
How Each Type of Income is Taxed
Earned income is the highest taxed form of income and subject to an additional 15.3% of SE tax. If you are a W-2 employee, you are extremely limited in nature to the amount of tax deductions that are allowable. If you have a small business the taxability of the income is the same as a W-2 employee, however, you have many more tax deductions.
Portfolio income is generally taxed lower than earned income. There are many factors involved such as filing status, tax bracket, the amount of time the investment held, etc. There are very few tax deductions that are involved with portfolio income.
Passive income is the lowest taxed form of income with the most amount of tax deductions.
Thus, you can see why it’s important to have a good base-camp understanding of the 3 types of income and how they are each taxed.
Earn Passive Income Online
As I’ve mentioned before, there are many benefits to aligning yourself with the future of technology and building an online business. There are literally 100’s of ways to make money online, but I personally believe that focusing on affiliate marketing is the best choice. Through researching a profitable niche, learning how to build a website, and maximizing traffic through providing keyword rich content you can build a passive income stream.
There are many niche markets in which you can profit, and the cool part is that you don’t have to be an immediate expert in that certain field. Realistically, all that it takes is a desire to grow and learn, you will soon become well-versed in your niche market.
Technology advancements today have allowed just about anybody with a pulse to build a website. The business start-up cost to build a website is by far the lowest start-up cost that exists in any industry. For less than $100 you can get a domain name, hosting, plugins, support, and many other features that go into building a website. In fact there is a free start-up option, I would suggest checking out a company named Wealthy Affiliate.
Generating traffic to your website can be accomplished through keyword research and quality content creation. The keyword research is vital in determining how to drive traffic to your website. I have found a company called Jaaxy
is by far the best at giving you the information that you will need to accomplish this task. After you have pieced together an amazing piece of content you can convey the piece with a blog, video, or podcast.
Over time, the more content you create, the more traffic you will generate which opens the doors for many ways to provide value to your visitors and monetize the flow.
Pay Less Tax with an Online Business
Yes! Building an online business does mean creating passive income that continues to pay dividends into the future. For tax purposes, however, there is nothing passive about building any type of business. If you are creating the income stream and working in the business daily, thus, you are materially participating in the business.
For this reason, an online business would be classified as earned income which subject to the highest tax rates.
The tax strategy to use with an earned income business is by incorporating the business into an S-Corp, or, an LLC taxed as an S-Corp. When you utilize the S-Corp strategy correctly you can forego paying the additional 15.3% SE tax on the profits of the business.
For example, if your business profits $100,000 in a single year, you would essentially save $15,300 in tax with an S-Corp.
Such a profound strategy!
With the favorable tax treatment, however, the IRS does require additional regulations. You will only be able to take advantage of the S-Corp strategy as of the day of incorporation moving forward. In addition, corporate officers are also considered employees in which a reasonable salary will have to be setup to take the first monies out of the business.
The good news though is that after the reasonable salary is paid, the owner can distribute the remaining profits of the business with a tax-free distribution.
If you desire a true passive income lifestyle, building an online business through affiliate marketing is a great way to accomplish this goal. As you begin to earn more, however, there will be tax consequences.
That’s why it’s important to learn how to earn passive income online and pay less in tax because the S-Corp strategy can save you a ton of tax!
To your passive income lifestyle,
Justin Ash, Founder/ Member