That's the progression
It's how it's set up. If you're an entrepreneur, you'll know about K1s soon enough. It's how the moderately rich, as well as the richest of the rich operate, mostly. Now let me tell you exactly how it works. First, dispense with the notion that those overseeing your tax code haven't an out for themselves.
You get your first job. You get a W2 in January. Celebrations. And if you're "lucky," the scheme says that if more of your own money was witheld than the thousands of pages of regulations dictate—that costs you $300-$400 in preparer fees should you wish to trade that for a few dozen hours of your "worthless time"—you'll get a refund. You get your own money back at zero interest. BIDNITMAN!
If you're "unlucky," you have to pay $1—so you didn't loan the Feds any money interest free over the year. But most people love a huge refund; it's part of the general social anesthetic and amnesia. Well, since America is a socialist country, now, that's all baked into the cake. The Fed is just like your best friend, helping you every day to live your life at the socialized expense of other people. Give 'em a loan at zero interest, just like your best friends.
There's one thing about a W2, however. You and your employer split the Socialism Security bill. It's on the order of 15ish% on the first $110,000 of income (0 thereafter, so if you make lots, no big). If you're an entrepreneur and have no employer, guess who pays the whole bill? You do. Great incentive to go out and start a business. On the other hand, for anyone you employ—in addition to all the other stuffs—you're going to have to pay that other half of the Socialism Security as well. Because that's what those who issue a W2 to people (employers) have to do.
So, if you are an entrepreneur, it might just be best for you to deal with everyone you can as independent contractors like yourself—on 1099—and everyone just pays their own Socialist Security Tax...that's that tax where old people who didn't see to their own old age can live at your expense because you still draw a W2 paycheck (note to old people: what you paid was consumed by far older people back when you were young; your "moral high ground" in this Ponzi Scheme is that you were stolen from, and so that entitles you to steal from young people just building their lives; be sure and thank your grandchildren and great-grandchildren).
A 1099 scheme is a best-of-worst way to get started, in spite of the tax disincentive. Most people just learn to live with that. Factor it, but when operating small, it's more important not to get bogged down. You have a lot of flexibility, all income you make in no matter what endeavor falls under the same umbrella. Unless you're an accounting obsessive, you can make that burden less onerous on yourself than with an incorporation scheme.
Often, people just starting out buy into the silliness over incorporating, justified by a whole lot of utter bullshit (by sellers of turn-key filing services). If you aren't very well into the multiple 6 figures ($100-200K +++) it's usually bullshit. Until you are very well into the money, the extra tax compliance will far outweigh any advantage to incorporation. Trust me. Been there, done that.
If you're tired of an employer and want to strike out, start as a 1099 entrepreneur. Don't bother forming a corporation. There will never come a time when flags pop out and it's too late to incorporate. Just like filing bankruptcy, you can always file for a corporate entity. Wait until necessary (I'm speaking practically, legally, of course—it's all total bullshit on principle grounds of freedom).
Once you have either made some serious money, have a business plan that contemplates it from the outset (e.g., involving Angel or VC investment), or already have a mature company, here's how you save TONS on taxes just like all the rich people, Congressmen, Senators and so on, do—while making regs over taxes for you.
But First! Contemplate this. What is all the political wrangling always about? It's about the "income tax." What do they mean? First, know that the tax code contemplates two distinct kinds of "income." One is the one everyone is familiar with. It's your paycheck (W2). It's also anything you earn as a contractor or entrepreneur (1099). The tax code differentiates that as "direct income." You could call it "sweat of brow" income, that's pretty much what it is. You are earning it directly, i.e., time, effort, piecemeal or contract.
And guess what? That's what the hoopla is always about (except Capital Gains, which is a big diversion, but I'll get to that).
What is never talked about? Indirect Income ("passive income"). This sort of income—90-100% of what guys like Warren Buffet make—incurs 0% Socialism Security tax or anything else like Medicare or any of that other stuff. It's about a straight 15% tax. The catch is that is has to be truly indirect....basically, income on various investments, or you're "cheating" to report it that way. Here's examples of truly indirect income.
- Dividends on stocks & bonds not wrapped in an IRA, 401K, Insurance policy or any or the other differed income strategies (you pay direct income taxes on that later, as distributions).
- Dividends or profit distributions from companies you're closely tied to. Maybe, you even started the company.
- Various other things like mineral rights, royalties and so on you may receive.
The biggie for you is #2. Here is your path to "the flat tax" of about 15%, that the very rich have always been doing. Yes, they pay W2 taxes on anything they make in that realm, but for most, it's a small percentage, so it's pocket change. Take a modern President. He makes about a half mil per year as a W2, pays all the taxes, people swoon, etc. Now, those millions he's going to make later in speaking engagements, book deals, consulting fees and so on? They'll all come under some tax structure like an S-Corp, LLC, perhaps even a C-Corp, but it won't be ex-pres running the deal DIRECTLY, and 100% of the millions that pass through to him will be indirect income. He's merely a stockholder in his own corporation collecting dividends.
BTW, movie stars and other high value folks have been doing this sort of thing forever.
Here's the challenge, though. You have to be big enough, enough activity that you can legitimately claim that you don't run the thing as top employee (and you can't be technically an employee at all). When I reorganized as an S-Corp in 2006, I had already hired a guy at $110K per year to run everything, fired myself, and I was in the office max once per week (justifiable, and I KNOW IRS audits). So, this is a path to lower taxation number one, and to let you know what a sucker they take you for, number two.
However, you can easily start getting savings now if you have a small business that makes decent money. Form an S-Corp or LLC. Take a guess on what proportion of what you get is the result or your own daily management efforts (W2, 1099, full brutal tax), and what proportion is as dividends or recompense from a growing investment (K1). Many go with 20% as 1099 and take the other 80% as K1.
Oh, yea, Capital Gains tax is how the rich people keep you distracted from indirect income. Look at it this way. They, or family, or a trust have been making income off an investment for eons (K1 and similar variants). It has paid for everything, taxed minimally (yes, tax guys, I know there are technicalities, here). Best you not know how little. Instead, depending on what side of the red or blue isle you reside, let's make a big deal about selling that asset that's been making money with little tax for decades, and what tax is payed on that single event at sale. Been working to keep you distracted forever. Try even to Google up much info about indirect income and taxation. I've been living that "dream" since 2006.
Now, better get that return stamped in time, all you voting taxpayers. The well being of the world depends on it.