Here is my situation:
First time investment, I will profit between 150k and 200k in 2005. I do not have a business entity, so right now this will be taxed as ordinary income since is is short term gains (less than 12 months). 33% sounds steep.
If I set up an S-Corp, I can take a salary (say $60k) and pay taxes at my normal rate. But I’ll also havr to pay the corporation’s portin of Soc. Sec. and Medicare. What happens to the profit left in the company? Will that get taxed too? What if I take a distribution on top of my salary, how will that be taxed.
If I set up an LLC, I believe I’ll be taxed the same way as the first scenario, right?
If I set up an LP, with a new LLC as the GP, what happens?
I am also going to invest in another deal similar to the first, it may show a profit in 2005, but maybe not until 2006. I am tempted to just not set up a business entity, but if I do future deals it makes sense. If I don’t do future deals, the entitiy will be stagnant.
Have you considered doing these deals using a Roth IRA so you don’t have to pay any tax on the profit.
There is a doggoned good argument that an using an LP gets you around all of the SS tax, unlike the S-Corp. In addition, if properties can end up as flips or buy and holds (the latter is usually involuntary, when the flip fails to flip!), an LP preserves the tax benefits of the rental. Finally, if you are in TX or CA, LP’s are taxed more favorably than LLC’s. Details matter, but LP is likely the way to go in your case.
Would you go into more detail about the LP avoiding the FICA taxes. What’s your experience and how can you set this up without it being considered self dealing (ie - you are/own the general parnter and the limited partner)?
Also, I’d like an outside opinion on the maximum dividend/salary ratio for an S Corp. What’s your experience on this?
Hey Dozer183e, I’m not 100% sure, but I think I agree that if you set up an LLC or an LP, the profits will just flow through to the partners (you’ll file a partnership return for either an LLC or and LP, and a K-1 for each partner’s share of profits, which will flow into your 1040). You wouldn’t pay FICA taxes or Medicare for either an LLC or an LP since the profits flow through to each partner.
If you do an S-corp and take a salary, you will have to pay FICA taxes and Medicare, but hopefully in the end it would still be less than paying taxes on the entire $150K.
Are you eligible for a 1031 exchange? That might be your way out of this.
LLC members pay SS tax. Code says S-Corp shareholders & Limited Partners do not. Courts modified S-corp law by requiring “reasonable salary” which IS subject to SS tax. They have not made such a ruling on LP, though they probably will one day.
There is no “magic number” for the salary to profit ratio. It depends on the arguments that can be made for a salary given the facts & circumstances in each case. I’ve heard alot of people say “40% of profits should be via salary”, but there’s really not much to back up such a generic ratio. I think SOME salary beats no salary, as the negative cases out there all involves situations where NO salary was paid. Pigs get fat, hogs get slaughtered!