I recently read info that mentioned protecting yourself from the self-employed tax trap. Also, I am presently trying to decide the best entity for asset protection and am confused. Can someone guide me toward a book that you recommend that covers this?
flips & rehabs are not capital gain transactions; they are ordinary income subject to income tax plus SE tax. This puts the total tax bite usually around 45%. I guess you could call that a “self-employed tax trap”…
Pass thru income from partnerships, S-corps (and LLCs taxed as them) is taxed the same.
The only means to possible avoid some SE is to tax as an S-corp, pay a reasonable salary to the owner, and then additional distributions may avoid the SE. If you can’t pay a reasonable salary, then this method does not work.
Therefore, I usually recommend C-corp taxation (usually 5% or 15%). Additional distributions will be considered dividends, taxable at 25%, but even this may be preferable to personal income plus SE taxes. It’s even better if you can leave the cash in the company (and avoid dividends) until such time as you can pay a salary, then convert to S-corp taxation to take advantage.
LLC is a stronger form than any corporation type, and can be taxed flexibly as a sole proprietor, partnership, C-corp or S-corp (with limitations). So you can get the superior protection of the LLC, plus whatever tax strategy benefits you the most.
sorry, I don’t know of any books.
Limited Partnership with an LLC as the General Partner. A little extra work to manage, but SE tax savings are worth it.
Get Goldmine of Brilliant Tax Strategies by Al Aiello. And of course spend the money and talk to a CPA.
limited partners are not passive if they spend more than 500 hours in the activity.
I would also bet that having the same individual in control of the management of the LP through ownership of the LLC probably violates the “lack of control” requirement of limited partners.
Thanks for the info. Now, I have to let it all soak in.
not that I wouldn’t be willing to take Matt’s position and sign the return - I’m not the one who pays the penalties - I just don’t think it will hold up under scrunity.
Read Aeillo’s Goldmine book. That goes into great detail concerning avoiding SE taxes and dealer status.
Mark may be right for all I know. We have been doing it that way for about 5 years now and our accountant files the returns for us. We basically followed the advice in the Goldmine book and then ran it by our accountant. We may need to “adjust” who some of the partners are to be safe. Will be checking into it more for sure.
Again check with the accountant in your area that you will work with.
talked this over with some other CPA’s at lunch. we all agree that this arrangement with a single owner as LP and as 100% owner of GP would not hold up under audit. We can’t think of a way the facts and circumstances could allow a single owner to not be in control of the partnership, and thus violates the prime requirement for LP passive activity.
How about if the limited partner was an self-settled, irrevocable trust?
that would take some research that, quite frankly, I’m not inclined to spend the time doing right now. :rolleyes
what, exactly, is a “self settled” trust? I’m not familiar with that term.
No worries, Mark.
A self-settled trust is a trust where the grantor (i. e. settlor) is the same as the beneficiary.
We actually are not a single member LP or LLC. I have a partner in the LP, but he is also the same partner in the LLC that acts as general partner. We may put our wives on one of the partnerships just to change the lack of control requirement.
That is a problem from a liability standpoint. Courts can collapse the entities if the directors are the same. It’s a good idea to use a non-managing owner with entities.
doesn’t sound like that would satisfy the limited partner control requirement, either. Having a small group of LPs also in control of the GP is still the same fundamental problem.
When you first started out and werent really making any money, did you still have an S-Corp tax election? Or did you form your LLC as a disregarded entity (basically sole properitorship)… Im kind of in that situation right now, not making much money and dont know if it is best to stay as a disregarded entity and just have it flow through or to make it so that i elect S-Corp and have to file a seperate tax return…
What are your guys thoughts?
I wouldn’t use an LLC starting out unless I already had an established business that I wanted to separate from the new venture. In that case, I would probably elect partnership taxation.
I didn’t need the cash, so I chose C-corp taxation, which lowered my income tax bite to 5% with no SET. I get cash out of the company in other ways: mileage reimbursement, benefits, travel to CA for director’s meetings, etc.