Very few people get rich working for someone else. Those who do are:
- The tiny fraction of actors who star in movies;
- Pro athletes in their twenties and thirties; and
- Partners in law firms, assuming you don’t count their divorces and cocaine habits.
Even United States senators don’t get rich off their $174,000 annual salaries. Oh sure, they get rich, but not directly via their salaries, if you know what I mean. They find all kinds of ways to create passive income.
So what about the remaining 99.999% of us? Are we all destined to nibble at the boss’ table, cross our fingers for incremental raises and hope that Social Security’s still there when we’re old and doddering?
If you have no ambition, then probably. For the rest of us, entrepreneurial ideas and investing are the only way to make it while enjoying self-determination.
Before you complain about this, you should be rejoicing. In most parts of the world, the only way to get rich is to stage a military coup and impoverish the peasants even further. This sounds like fun until you remember that doing so puts you in the crosshairs of the next coup-stager.
This bears repeating – the list of America’s richest people consists of nothing but entrepreneurs and their heirs. There isn’t a salaried employee in the top 50,000. Fortunately, starting a business in this country remains relatively free of red tape. Relatively.
But if you’re going to start a business, do it right. Millions of aspiring entrepreneurs make the mistake of merely securing an operating license from whichever local jurisdiction they plan to do business in and not going any further. (Read “How to Start Being Self-Employed in Six Months.”)
Unless you specify otherwise, your business will run as what’s called a sole proprietorship (or if you’ve got partners, the cleverly named “partnership.”) Madness this is, because under it you (and your partners, if any) are the business. For tax, credit and legal purposes there’s no difference between the business and yourself. Which means there’s nothing to stop a motivated litigant from suing you for more than you’re worth.
Instead, the first thing any nascent entrepreneur should do – before buying a coffee mug or even writing a business plan – is figuring out the right way to structure her new enterprise. For most people, that’s going to be as either an LLC (limited liability company), professional LLC or an S corporation.
Limited liability means a company’s owner(s) can’t be sued for more than what the company’s worth. No one can come after your personal assets, that is. It sounds like an unusually defensive way to get started – testing the alarm system before building the house – but that’s the society we live in.
An LLC doesn’t pay taxes. Instead, the LLC distributes profits among its owners, which then get taxed at the same rate that the wages and salaries of regular people do. Your LLC issues you an IRS K-1 statement, easy enough to do if you own the LLC, on which you list your share of the company’s income and expenses. These then get transferred to the good old 1040 form you know and loathe.
An S corporation (it takes its name from Section S of the Internal Revenue Code) also doesn’t pay income taxes. And, it also divides profits and losses among the shareholders. The biggest difference between an LLC and an S corporation is how the IRS treats profits. If your S Corporation pays you a “reasonable” salary, the remaining profit is “distributed” to you at the end of the year and isn’t subject to self-employment tax. Not so with an LLC. The tradeoff is that an S corporation requires a little more paperwork and filing.
Excuse me, self-employment tax? The hell is that?
Seriously? Thanks, I’ll just keep working for the man, then.
Fine, but you’re paying that 15.3% as it is. If you make under $106,800, the feds deduct 6.2% of that in Social Security taxes and another 1.45% in Medicare taxes (government programs that just keep on giving.) Furthermore, by law your employer’s on the hook for the same amount – 6.2% and 1.45% respectively. Go ahead, add those all up. And remember that taxes, all taxes, aren’t paid by overweight industrialists chomping cigars behind oak desks. They’re paid by you and me.
With an LLC or an S corporation, you pay yourself a salary and deduct from your taxable income everything that’s directly related to the maintenance of your business – your phone bill, car expenses, health insurance premium, etc. A smart entrepreneur distinguishes between Form W-2 income, which is the kind hourly workers and salaried employees earn, and Form 1099 income. The IRS defines the latter as everything other than wages and salaries.
But there isn’t only one Form 1099. There are dozens. One for dividends and distributions, one for real estate transactions…you want as much income as possible to come from these and as little as possible to come from W-2s. When it comes time to file your taxes, and include all those deductions, you’ll appreciate the difference.
Greg McFarlane runs ControlYourCash.com and wrote Control Your Cash: Making Money Make Sense, a financial primer for people in their twenties and thirties who know nothing about money. Get the physical or Kindle edition and reach Greg at greg at ControlYourCash.com.
Hi – nice post. First time here.
I would argue that partners in a law firm are not employees. Much like entrepreneurs they have to build a client base, keep their customers and happy and take a share of the profits. If profits go down, then they lose money or worse, lose their business.
And you can get seriously rich working for someone else. Just look at investment bankers or guys working for private equity houses. Or CEOs of most corporates. IF your defintion of rich is a couple of million (or maybe even hundreds of millions), the top of almost any Fortune 500 has lots of rich people.
Great post. It would be interesting to see a follow up post about the actual wealth of entrepreneurs versus those that work corporate jobs. Unfortunately, only a small percentage of entrepreneurs get rich and this is caused by a variety of reasons. So I would agree that it is more likely to get rich as an entrepreneur than working from someone else, but it is not easy or guaranteed.
Neal@Wealth Pilgrim says
Greg, You are right…I should have reversed the order…it does sound much better. Thanks for a great guest post Greg. Keep ’em comin’
Greg McFarlane says
Thanks for the comments, everyone.
I’d never heard Neal’s pithy summation before: While most rich people are entrepreneurs, most entrepreneurs are NOT rich. (Although if you read the phrases in the reverse order, it sounds a little more hopeful.)
I wasted my 20s wearing a suit and tie and hating every second of it because…well, because it’s what you’re supposed to do. If the trappings of regular employment sicken you as much as they did me (groveling for raises, making a big deal of not only coming early and/or staying late, but ensuring that the right people see you supplicate yourself, etc.), don’t rationalize it. Quit now and stop punishing yourself. The world will do plenty of that without your help.
It depends on your definition of getting rich. Corporate executives and Wall Street traders, whom people are not fond of in general, are paid very well. They can be thought of as “working for the man.” You will get rich if you are successful in your entrepreneurship. There lies the rub. It has to be successful and success doesn’t come just because you quit your job.
Neal@Wealth Pilgrim says
Excellent point TFB.
While most rich people are entrepreneurs, most entrepreneurs are NOT rich. A good reminder that we have to do more than simply hang out the shingle. I’ve never believed that if you build it they will come.
That understanding reminds me that in order for my business to succeed, I have to pay attention to my boss – my clients.
There is no way I will get rich working for the man. Climbing the corporate ladder is not something I’m good at or want to do. Entrepreneurship is the only way I will be rich. My goal is not getting rich though, just comfortable. 🙂
The S corp. is great, much better than sole proprietorship.
There are people who do very well working for large corporations with stock options, bonuses and great benefits. I know, I was one a long time ago. If you want to reach your own personal destiny, you must venture out on your own. That has pitfalls, but it is up to you.
“Excuse me, self-employment tax? The hell is that?” / “Oh, 15.3%.” / “Seriously? Thanks, I’ll just keep working for the man, then.”
Bahaha! That had me rolling! For most entry-level entrepreneurs (and many seasoned ones, as well), I believe a Sole Proprietorship is probably the best way to go. It really does make life so much simpler! 🙂