Is there a difference between setting up a sole S-Corporation vs setting up an LLC and tax it as an S-corporation? I hear how setting up a LLC is easier to maintain and that S-Corporations can be a pain in the butt. My question is, are there alot of investors out there going w/ this route or are they just doing S-corporations only?
I’m a new real estate investor starting out, and I plan on doing flips to build my cash reserves, and was wondering if this is the best strategy to use.
mc wagner is a brilliant CPA and I’m sure he can answer your question better than I, but LLC’s seem to be the way to go.
Da Wiz
BIG difference.
Plain 'ole S-corp is a corporation. You own stock. Corporate stock is considered an “investment”. Investments are available to satisfy judgement creditors if you are personally sued. So you rear-end someone in a Pinto, get sued, and lose, they get your investments and suddenly they own the corporation and all of its assets.
Member interest in an LLC is considered personal property by statute. As such it is not available to satisfy a judgement creditor. You lose the case, but the best they get is a charging order against LLC income, which you can frustrate. Meanwhile, you remain owner and in control of the LLC’s assets.
Both the S-corp and the LLC protect you from liabilities arising from within the company. Only the LLC protects the company from your personal liabilities.
let’s say i make an LLC, which is taxed as an S-Corp…
S-Corp’s dont pay taxes, right? only the distributed profit to the shareholders gets taxed on the individual’s level, right?
So if my LLC buys a house, and sells it, and makes a 100 grand, the company doesn’t pay any taxes on that profit? Only I do if I pull the money out, right?
And if I don’t pull that money out, the LLC never pays taxes on it either? Is this how it works? If so, how long can I keep the profits sitting in the LLC?
Can somebody explain this to me? thanks.
thanks
Let me say up front that I am not an accountant and I did not stay at a Holiday Inn Express last night either. Now, that being said, here is what I understand:
The LLC (taxed as partnership) is a flow through entity in that the profits or losses of the entity will pass through to the members via K-1’s. So, the answer is yes that the company doesnt pay taxes on your $100k profit, but the members will.
On the S-Corp question, my understanding is that the distributions are taxed at the individuals level, without FICA. However, I think there are issues if you make a lot of money in your S-Corp and dont pay out any salary, which would be subject to FICA.
Pretty much every piece of advice I have received from the accountign community is to hold long-term rental proeprty in LLC’s and to do all of your short-term flips in an S-Corp, or LLC taxed as S-Corp.
After reading MCWager’s previous response, I can’t see any reason that I would pick an S-Corp over an LLC taxed as S-Corp. The latter seems to provide all the same benefits, but with better liability shield from outside the company…
Agreed, the LLC taxed as S-corp is preferred over a “regular” S-corp simply because it is not a corporation (with the corporate stock problem).
For Butler:
Many people try to compare LLC taxes with S- or C-Corp or partnerships. This is an invalid comparison. You can’t make a tax comparison between an LLC as “just an LLC” and some other entity. Since the LLC is flexible with regard to taxes, you must compare the LLC’s tax election with the other entity. An LLC as such is nothing to the irs: there is no tax law for “LLC”. So your advice to “do long term in an LLC” makes no sense… you have to know how that LLC is being taxed. Make sense?
For 604’s question:
The LLC taxed as s-corp will pass thru the income to be taxed at the individual’s personal rate. Further, if the S-corp income is capital (selling a rental property) then that will be taxed as capital gain to the individual. If it’s regular income from a flip, then it is taxed at marginal rates. Plus, this income is usually subject to self employment taxes (unless it is passive rental income). Ie: the income maintains its “character” when flowing through to the members.
However, if the S-corp pays the member a reasonable salary, then you can avoid the self-employment taxes on the rest. This is where S-corps win over partnerships. Partnership taxation has no such provision.
All of this is taxed when earned. Any distributions you take from an S-corp are not taxed at distribution.
That help?
Mark,
Since I’m starting out as a REI’er, how do I pay myself a reasonable salary if I’m not making that much? Let’s just say I make only $20,000 from doing flips, how would getting an LLC and tax as an Scorp work?
Mark, I think you are referring to this previous quote of mine:
Pretty much every piece of advice I have received from the accounting community is to hold long-term rental property in LLC's and to do all of your short-term flips in an S-Corp, or LLC taxed as S-Corp.
What I should have said was “to hold long-term rental property in LLC’s (taxed as partnership)”. My understanding is that partnership is the default election for an LLC and so I tend to use that as the implied election when I just say LLC. Im just a layman meddling around in a CPAs world when it comes to this stuff…
Thanks for further clarifying that my omission was ambiguous at best. Also, thanks for the many posts of yours on this subject matter.
if long-term means rentals, then the choice of entity is largely irrelevant since passive income avoids the SE tax anyway. so whatever is simpler, and partnerships are simpler than S-corp. Keep in mind though, that if you work more than 750 hours a year managing your rentals, you could be considered a “real estate professional” and the passive exclusion goes away.
I just wanted to make it even MORE complicated for ya!
bald: Reasonable means something like “what you would normally have to pay someone for the same experience, doing the same job for the same hours”. Usually for small timers, the cost and hassle of setting up payroll isn’t worth the savings. However, for someone with a sizeable portfolio, paying yourself a salary and avoiding SE on the rest can be significant.
EXCELLENT EXPLANATION
thank you very much!
i still don’t fully understand the self employment tax thing, though. so you are saying, if my LLC (taxed as S-corp), makes a 100k profit, and I dont pay a “reasonable” salary to myself from that, the money has to be taxed (SE tax). But if i take a reasonable salary, then I can avoid the SE tax?
yep
Headache* I was about to register as an S corp.
Here’s my scenario.
I am a single person who intends to wholesale:
Q1. Is the LLC taxed as an S corp still the best option?
Q2. If you are a single member LLC, are the rules and benes the same?
Q3. Can I still utilize the kids (over age 8) in the biz, and pay their salary $4700, to an IRA ?
Now, THEY can contribute to an IRA to lower THEIR taxable income.
So, let’s say I have three children, ages 15, 16 and 17. I hire each one to work for me in my business and pay each one $8,200 in 2005. Because they are all under 18, I pay no Social Security, Medicare or state unemployment/disability taxes. Because of the standard deduction, in 2005, the first $5,000 earned by each child is not taxed. ($5,150 in 2006 I think.)
The next $3,200 could be sheltered by setting up IRAs for each child – although at their ages, a nondeductible Roth IRA might be a better long-term investment.
The net result is that I have paid my children a total of $24,600 ($8,200 x 3) that I can deduct and is tax-free to my kids. If I am in the top marginal tax bracket of 35%, I’ve just saved $8,610 each year in federal taxes alone. When I add state tax and Medicare savings to that, I could save probably as much as $10,000 more per year.
Nothing here is leading edge or in any way questionable. Given that you have appropriate documentation and substantiation for your deduction, the only issue the IRS can raise is the “reasonableness” of the compensation. Keep good records and don’t try to pay a 14-year-old child $50,000 a year to file your papers once a week, and it’s an easy win.