I have seen a lot of coverage on here about LLCs and not much on C/S Corporations and wondered the reasoning of this?
With everyone on here having something to do with RE in some form or fashion, I would like to pose the question to anyone who is incorporated through a C/S Corp, and why? Why also, instead of a LLC? Lastly, what is the best way financially and gainfully to go about incorporating?
Thank you in advance for your replies.
-POMTE
Hi,
The type of entity as a choice of C - CORP, S - CORP or LLC is directly related to your purpose and use of your corporate entity.
Most investors use LLC’s because it’s a direct management entity and it has the ability to choose flow through dispersement of cash and tax write off’s directly to a persons personal income tax return.
An S - CORP although operated like a C - CORP this type of corporate entity allows for dispursement of cash and the ability to carry losses over into your personal income tax return but also benefits the owner in the ability to quantify specific wages and pay the specific earned income taxes for social security and medicare. So if you make $100,000 you can specifically pay yourself $60k and pay social security and medicare against $60k and distribute the balance of $40k as corporate profits.
An S - CORP is not taxed as a corporation under IRS tax code but rather a flow through entity to personal income taxes.
A C - CORP is strictly a stand alone corporate entity, it pays taxes as a corporation, employee’s are paid wages and owners are issued stock and paid dividends, if you own a C - CORP and want to distribute profits the C - CORP first pays corporate taxes then a check when written to an individual stock holder must pay taxes against income again, thus double taxation.
Now I may use C - CORP’s for control under a specific name “Real Estate Investor, Inc.” for example and the C - Corp may control the management interest’s in LLC’s and I may only own 1% of the LCC, the C - Corp may only own 1% of the LLC while a Trust owns 98% of the LLC. This actually allows distribution of potentially up to 98% of the income / profits and write off’s from the LLC while limiting exposure.
Or I may use a C - Corp to run and operate a service company that operates purposely with little or no profit! An example would be managing my own properties in a specific state and providing management fee’s from LLC’s specificly planned to cover cost’s and expenses without providing to much pay creating profit’s.
GR
There is no tax code for LLC. You may choose to tax the LLC as a sole proprietor (Sch C), partnership, C-corp or S-corp, depending on how many members (owners) there are and your financial objectives. This gives the LLC tremendous flexibility that the other entities don’t have.
LLC is easier to administer because unlike true corporations, there are no hassles with shareholder meetings, minutes and recordkeeping.
In a multi-member scenario, LLC provides superior liability protection. Both corporations and LLC’s protect the shareholder from liabilities arising within the company. Only the LLC provides the company protection from liabilities of the individual members.
So LLC’s provide all of the benefits of the other entity types, superior liability protection in some cases, with less hassle. That’s why LLC’s are popular.
Gold’s post is accurate, but a couple of points should be made:
Yes, an S-corp (or an LLC taxed as an S-corp) can save self employment tax. But only if the entity is driving enough cashflow to pay the salary plus the distribution. Otherwise, this benefit is moot. Then there’s the not insignificant hassle cost of running payroll.
Also, rental income is always passive and not subject to SET. So choice of entity makes no difference to your total tax liability if you’re holding rentals.
Why someone would have a setup with a 2% C-corp management company setup is beyond my understanding. This makes sense only in the context of multiple passive investors. A single (or married) owner receives no “protection” benefit from this setup while saddled with the additional hassle of complex bookkeeping/taxes (that they usually screw up anyway.)
I heard some people are scared of S/C corps because the corporation veil can be pierce.
All,
Let me first say thank you for those of you who take the time and your expertise and hold the hands of us fledglings. That being said…
This totally goes against what I have learned that LLCs are limited in fully protecting the business owner. I understand that if I’m Joe Plumber and I accidentally flood a client’s home that I’m personally financially and legally responsible without my business under the cloak of a corporation. I understand that as asset protection 101.
That is what I’m making sure I do the right way from the get-go, is to protect myself from Murphy’s Law and greedy, sue-happy individuals who are out to get me. I want to ensure that I’m protected, as well as my home and any other liabilities that someone could go after through a lawsuit.
Thanks again to the legal guru’s.
That begs my last question, am I able to put my home under an LLC if I do business out of it? Is that an individual LLC for the home? Does that protect my home?
-POMTE
To answer your question is yes. Remember there are very sharp lawyers out there that will drag you through the courts just to cost you money when suing you of your LLC. Most lawyers will sue you and your LLC and list john does inside the LLC. It is not hard to find out what the LLC is protecting…
Good insurance, good insurance, and good insurance…
Remember to ask what the price difference is between what the insurance agent quotes you for a policy vs. taking out the insurance company’s maximum amount of liability insurance. The premium difference is usually quite small for the difference between 300k of liability vs. 1MM.
That is a good policy to have business insurance.
I am not an atty and not licensed to practice law.
A single member LLC provides little to no asset protection. Especially if you are personally managing the properties. You will always be personally responsible for your personal actions. You as the property manager didn’t replace the loose board. You will be personally sued. The property owner LLC will also be sued. No entity will remove this liability from you. Ever.
It gets a little better if you are using an unrelated management company. Then the property owner LLC is sued, and the management company is sued, as well as the person at the management company that was negligent. (This is why owning your own corporate management company is false protection. You will still be personally sued for your personal actions, even if you are acting as an agent of the management company.) At least in this scenario, your other assets outside the LLC are protected, ASSUMING that the property is properly owned and titled in the name of the LLC. If you personally purchase the property (as most banks require) and then deed the property to the LLC, things get tricky.
A multi-member LLC is intended to provide protection for a member from liabilities arising from another member’s actions.
example: LLC owns rental. Member A, the town drunk, negligently kills a kid while driving drunk. Member A is sued and the plaintiff wins a judgement against Member A. Charging order protection prevents plaintiff from taking ownership of Member A’s personal property interest in the LLC, and potentially forcing a sale that harms Member B. Thus both the LLC and Member B are shielded from damage caused by Member A’s personal liability outside the LLC.
Same scenario. This time it’s an S-corp. Plaintiff wins judgement. Corporate stocks are considered an "investment " of A, and are awarded to plaintiff to satisfy the judgement. Now Plaintiff actually owns shares of the S-corp that owns the property. If plaintiff now owns a majority interest (or even a significant minority) plaintiff can force a sale, force condemnation, prevent repairs, or a host of other bad news that will have a negative impact on B.
Little different scenario: Member A is property manager and fails to repair the loose board. Betty slips and breaks her neck. Member A is personally sued. All his personal assets (house, car) are at risk. The LLC is also sued, putting the rental property at risk. Member B is a passive investor and was not personally responsible for the accident. Mmber B’s personal assets are protected. He may still lose his part of the rental house, but his home and other personal assets are not at risk. He would receive this same protection from an S-corp or C-corp.
So we see that both a corporation and LLC provide the same protection from liabilities arising from INSIDE the entity, but only the LLC provides protection for a member from liabilities arising OUTSIDE the entity.
So, what are you trying to protect, and from what?
More regarding single member LLC’s.
Many states’ courts have recently ruled that a single member’s personal assets are available to satisfy judgements against the LLC.
to continue our examples: Single member LLC (SMLLC) owns a rental property. member is using a management company that is independent of himself. Member is not personally involved in any “operation” of the rental property: doesn’t meet with tenants, doesn’t collect rent, do repairs, nothing. Management co fails to repair board, Betty slips and falls. LLC, management comany and Fred the property manager in charge of repairs are all sued. Plaintiff wins judgement. Fred is personally liable. The Management company is in trouble, but we don’t know (or care) how bad. The LLC may also be found liable, and the judgement can be enforced against the LLC or the rental property.
Here’s the kicker: several states have ruled that the single member is also liable in the judgement, explicitly stating that the wording of the LLC statute implies that charging order protection is intended to protect one member from another member’s actions, and that this protection does not apply in a SMLLC scenario. Some states are attempting to rewrite the LLC statutes to clarify this issue. For now, a SMLLC may or may not offer protection to the SM.
Now, take this same example but now the SM is also personally managing the property. He’s screwed.
If you’re a SMLLC – have good insurance. Or consider adding another “friendly” member for 10% or so to tap into the superior protection of a MMLLC. But remember that even this will not protect YOU from YOUR personal actions.
It was always coached to me that common practice in forming a corporation, LLC, C/S Corp, was to protect an individual, whereas the business and not the individual would be held liable.
Bottom line that I’m getting from this is that someone could go after the business, individual and individual’s assets regardless?
Therefore, forming a corporation or LLC is beneficial solely for tax purposes? Because, in the event of a lawsuit, you end up doubling the assets at risk if incorporated?
I think what really ensures protection is the insurance side of the house as Justin pointed out.
It is not hard to find out what the investor is hiding behind a LLC, C/S corp.
LLC stands for “Limited Liability Company.” LLC is an asset protection strategy, not a tax strategy.
There are no tax advantages to an LLC. None. Business expenses are always deductible irrespective of the choice of entity.
An LLC is taxed as either a sole proprietor, partnership, C-Corp or S-Corp. There may be tax advantages - or not - to an LLC taxed as an S-corp, as previously discussed.
From an asset protection perspective, a SMLLC has little value (at least until the states address statutory weaknesses) for protecting the member’s personal assets.
A SMLLC has zero value for a member-managed rental property because no entity will protect an individual from the consequences of that individual’s personal actions.
Nor will an entity protect a property from a liability arising at that property (or another property owned in the same LLC). The property owner can always be sued.
A Multi-member LLC DOES offer significant asset protection benefits, offering protection for a member’s personal assets from a liability arising inside the LLC ASSUMING that the member is not actively managing the property. A MMLLC also provides protection for a member’s personal assets from a liability arising from another member that arises outside the LLC.
LLC is a great tool. But it is not “total liability protection from everything for everybody.” You have to understand when it is effective – and when it is not.
Hey Mark, this may be a silly question (I’ve been known to ask them), but if a rental property is in my name and my husband’s name, is that a “multi-member” situation?
I’ve got an LLC right now for a marketing business that I’ve recently “retired” from. I asked a lawyer if I could “repurpose” that LLC for real estate investing. He says yes. But after reading some other threads here about LLC versus liability insurance (for protection against lawsuits & whatnot), I’m wondering if an LLC is necessary. In California it’s $800 annually just to have an LLC – that would be on top of the insurance I’m already paying. California even charges for dissolving an LLC ($250), so I’m wondering if that makes more sense… just forget about the LLC.
I do plan to buy additional rental properties in the future… but the lawyer said “it’s POSSIBLE to have several properties within one LLC, but for the best asset protection, they should be in separate LLCs.” Cha-ching!
Since there are no tax benefits to LLCs, and a good liability insurance policy should protect my husband and I from sue-happy tenants, I’m wondering what the upside to an LLC might be. Am I missing something?
“multi member” is a term referring to ownership of an LLC. "single member " and “multi member” are the two different scenarios. if you don’t have an LLC then multi-member is irrelevant.
if you just own property in your names, then (depending on how it’s styled) you just have joint ownership with right of survivorship or something like that.
I would never re-use an entity. You wouldn’t want some long forgotten liability arising from the old business to come back and wreck the new business.
the point of an LLC is not tax benefits. the upside to LLC’s are as described above: when formed and used properly they provide asset protection for the members and the entity.
Mark, thank you so much for your explanations – and your patience with more questions. :biggrin
You said “If you personally purchase the property (as most banks require) and then deed the property to the LLC, things get tricky.”
That’s exactly what my lawyer is advising me to do – My husband and I recently bought a rental property. The lawyer said to buy it in our names, and then transfer the deed of that property to an LLC.
Can you please clarify why/how this can get tricky?
My head is about to explode trying to figure out the pros and cons to (a) creating an LLC specifically for real estate purposes – with just my husband and me as members (does a married couple count as a “single member” within an LLC?); (b) finding someone else to join the LLC so it can become a multi-member LLC for better asset protection; or (c) forget having an LLC and just rely on great liability insurance to protect us and our property.
I guess my bottom-line question is: If we have the maximum liability insurance coverage, is it worth another $800 per year for an LLC that would have only my husband and me as members. (We’ve hired a third-party property management firm to handle the rental and are not personally involved in that. They’ve asked to be name as “additional insured” on our insurance policy.)
Thanks again for your help!
the bank wants the person who is obligated on the mortgage to own the property. You have no way to transfer the mortgage, so if you transfer the property to the LLC several things can happen:
The bank won’t like it. When you get ready to sell, they will require you to transfer it back. If they find out about the transfer, they will require you to transfer it back. You will have to personally purchase the insurance, because the bank will expect the insurance to be in the owner’s name, and they think that’s you. You may have trouble purchasing insurance on a property you don’t own. You may have problems with insurance if you ever have to file a claim on property you don’t own. Who are the tax authorities going to pursue for taxes on this property you don’t own. In a worst case scenario, they can get you on the “due in full” clause of the mortgage.
You get the idea. Yes, I’ve seen all of this happen.
I also have a lot of clients who have done it with absolutely no problems. Your mileage may vary.
Better to approach a local bank about purchasing the property (or refinancing) directly in the name of the LLC.
LLC laws vary by state. You’ll have to ask an atty if a husband/wife constitutes a multi-member LLC in your state.
Yikes! :shocked
Funny, the lawyer didn’t mention any of these potential transfer troubles. I wonder if that’s because if such problems arise, they’ll offer their services to help me get out of them. (I guess lawyers bring out the cynic in me.)
Thanks again, Mark! You are amazingly generous with incredibly valuable free advice!
Oh… I realize I’m probably reaching pest status with all these questions, and “each situation is different,” but what’s your general opinion about whether it’s worth $800 per year (the annual fee in Calif.) to have an LLC, versus just having great liability insurance?
$800/year buys a lot of insurance.
Indeed. Thank you, Mark. I really appreciate your help.