This info will go a long way in helping those trying to dicsover the difference between corporate entities. Please READ ON!
Choice of Entity 101
by John Hyre
One of the most common questions that real estate investors ask is: Which entity should I use? The correct answer usually depends on a large number of details…the exact nature and size of the business, the investor’s source and type of income, the number of family members, etc. This article will set out some general rules for picking a structure. Your mileage may vary based on your own personal facts and circumstances.
Rule One: Limited Liability Company’s (a.k.a. – LLC’s) are generally the way to hold rentals and most lease-optioned properties.
The asset protection aspect of entities usually matters little when selecting an entity. That’s because in most states, LLC’s are cheap, provide the best asset protection and are tax chameleons, meaning that they can select how to be treated for federal income tax purposes. So when I say that a corporation works best for you, what I really mean is that an LLC that elects to be treated as a corporation is the best choice in most states.
What really distinguishes entity types is the tax treatment accorded each one. As such, choice of entity usually turns on the applicable tax rules. In fact, tax rules will determine the best entity for rentals, because they are the little darlings of the tax code. Specifically, rentals:
sell at favorable capital gains tax rates; generate depreciation deductions; generate tax upon sale that can sometimes be paid in installments, instead of all at once; can be exchanged for other real property tax-free; and may generate low-income housing credits
We want to select an entity that preserves these tax perks. Limited Partnerships (“LPs”) and Limited Liability Companies (“LLCs”) both achieve this goal better than any other entity. In most states, an LLC is cheaper and simpler to set up and run, so it is normally preferable to an LP. In addition to preserving rental property tax perks, LLC’s are the most flexible entity. Corporations have various restrictions on who can be an investor, what kind of income can be earned, etc. LLC’s are thankfully free of such pesky (and time consuming) issues.
Rule Two: S-Corporations are usually the best way to flip properties.
First, let’s distinguish S and C corporations. A C-Corporation is taxed on its income at special corporate rates. Any income that is paid to shareholders as a dividend is taxed again. This is the famous “double taxation” that applies to C-corporations.
For example:
Trumpco Incorporated earns $10,000 in taxable income. It pays a 15% tax on that income, or $1,500, leaving with $8,500 in after-tax income. It pays an $8,500 dividend to Trump, its owner. If Trump is in the 35% tax bracket, he will pay $2,975 in taxes on the dividend, leaving Trump with $5,525 of the original $10,000.
This double tax can quickly cost corporate shareholders more than 50% of their corporation’s profits. Fortunately, the income of a C-Corporation can often be finessed to reduce the double tax. Oftentimes, creative means of getting money to shareholders (e.g. – renting equipment to the corporation, taking salaries, etc.) can also eliminate one layer of taxation.
To offset the double tax (or the administrative cost of getting around it), C-corporations have a few unique perks enjoyed by no other entity. Employees (including shareholder-employees) can get certain benefits (e.g. - medical, favorable retirement plans, tuition payments) tax-free.
S-Corporations do not get the above perks, but they also do not have double-taxation issues. As such, they are “pass-through” entities. Following the Trumpco example from above, the $10,000 dividend to shareholders would only be taxed once, at the shareholders 35% rate. S-corporations are much simpler than C-corps, and therefore cheaper to operate. They are less flexible than LLC’s, but have one important advantage: S-corporation dividends are exempt from social security taxation if the S-corporation owners are paid a reasonable salary. This feature is quite important, because income from flips (as opposed to rentals) would otherwise be subject to a 15% social security tax.
For example:
The incredible Flipboy makes $80,000 in net income from wholesale flips done through an LLC. He would pay approximately $12,000 (15% of $80,000) in social security taxes. If he used an S-Corporation and paid himself a “reasonable” salary of $35,000, he would only pay social security tax on the salary, or $5,250. The remaining $45,000 in profits would be distributed without paying additional social security taxes, saving Flipboy $6,750 in social security taxes.
Limited partnerships are also exempt from social security taxes. Arguably, LP’s are not required to pay a reasonable salary, meaning that all of the LP’s profits can be sheltered from social security taxes. The catch: LP’s are significantly more complicated than S-corporations and therefore more expensive to run. The extra benefit of an LP over an S-corporation for flips must be weighed against the cost.
Rule Three: C-Corporations often make sense for high-income individuals with self-provided benefits.
As we stated above, C-corporation can provide certain perks and benefits tax-free. If you do not have a day job (or a spouse with a day job) that provides such benefits, getting them through a C-corporation can be very efficient from a tax standpoint. Also, I mentioned that C-Corporations pay taxes based on their own brackets. For example, the first $50,000 of C-Corporation income is taxed at 15%. For people in the 35%+ tax brackets, running $50,000 or so in income through the C-corporation at a 15% tax rate can be quite favorable. I say “can be” because C-Corporations are fairly expensive to administer. Remember, the benefits must outweigh the costs (e.g. – extra tax returns, bank accounts, etc.).
I rarely place a major business in a C-Corporation. Instead, I like to see secondary businesses put into a C-Corporation. For example, a C-Corporation that manages your rentals is paid what you choose to pay it (within reason!). You can pay it enough to fund your benefits, but not so much that double-taxation becomes an issue. If you put a major business into a C-Corporation, it may make “too much” income. At worst, the double tax kicks in, costing you big dollars. At best, your tax advisor finds a way to bail the income out of the company….and charges handsome fees for the favor! In my view, it is much easier to put the C-Corporation on an “income diet” than it is to “lose” the income later on (Sound familiar?).
Rule Four: Incorporate in Your Home State
I have yet to see a Nevada entity used to hold or flip properties that justified its cost. All of the benefits promised by Nevada entity hucksters (e.g. – privacy, no state tax) DISAPPEAR because you are doing business in YOUR state. Nevada entities CAN be used to reduce income taxes in SOME states by charging your in-state company interest – talk to someone familiar with YOUR state’s rules to see if such an arrangement is legally possible AND worth the cost and hassle. Do NOT accept the word of a guy who sells Nevada entities for a living. Shockingly, he will assert that a Nevada company will save taxes, promote privacy, make you better looking and cure cancer…all without having the first clue about the laws in YOUR state. To a guy with a hammer, everything looks like a nail!
Rule Five: Your Mileage May Vary
These are general rules. Your business, personal situation or state’s laws will often make for exceptions to the general rules. Get qualified advice!
Anita
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TWITTER - anitarny / FACEBOOK - anitarny
"FAILURE IS NOT AN OPTION"
that can be added to this thread would be greatly appreciated. This may be a big help to those looking to find answers on the difference in the corporate entities
Anita
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TWITTER - anitarny / FACEBOOK - anitarny
"FAILURE IS NOT AN OPTION"
I am completely new here, and new to this business. I am so excited to have found these books and be able to see the information that you all share here. It is great to be a part of something POSITIVE. Everyone here helps others to learn and grow. It is a rare thing nowadays, with everyone looking out for number one only, to see people who truly care about helping someone else out without the expectation of something in return. This is a wonderful site and I am glad I found it!![Smiling Smiling](http://mail.deangraziosi.com/modules/smileys/packs/example/smile.png)
sorry it took me a while to respond but i just saw the post. you are most welcome and we are glad to be here to help
Anita
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TWITTER - anitarny / FACEBOOK - anitarny
"FAILURE IS NOT AN OPTION"
this priceless info. I will add this to my toolbox. Thanks,...Pete
Thank you for the info. I'm reading this after we set up our business, however, it confirms we made the correct choice for our entity. Any positive is motivation to move forward.
"If he used an S-Corporation and paid himself a “reasonable” salary of $35,000..."
This reminded of some questions I had about incorporation:
- How do you go about deciding on a "salary" for yourself when you choose an entity?
- How & when would you pay out?
- Is there a minimum/maximum you're legally allowed to pay yourself, is it based on the amount of money that goes through your entity, or just whatever you want to pay yourself?
- Which would be the best entity for assigning/ bird dogging?
I've done some Googling on incorporating & paying yourself. Maybe I'm not using the right keyword combinations, but I haven't found any sites that talk about this in detail. If anyone has the answers, I'd be super grateful to having them cleared up for me![Smiling Smiling](http://mail.deangraziosi.com/modules/smileys/packs/example/smile.png)
Other than needing those questions answered, this was a very detailed thread about corporate entities (in general) in regards to R.E.
Thanks Anita!
Celisse
First of all anyone who invests in real estate should set themselves up with an LLC. It is easy and you can do it online.
The benefits are abundant. I was coaching one of my clients that had purchased 1.2 million in properties and he called in because his bank would not extend anymore credit to him.
I explained to his that he should start purchasing properties through his LLC and not using his own credit.
Sure enough it worked! He said he probably knew that but did not think of it till I mentioned it.
You may also want to set up a business entity within your state. This can be along with your LLC a tremendous tax benefit for you.
Randy
Hi. I read a book "ASSET PROTECTION 101" by Donald J. Trump and another author. It mentions pretty much everything you want in order to proceed forward with your business.
I hope this helps.
'Fortune Favors The Bold', Francis Lambert
The benefits are abundant. I was coaching one of my clients that had purchased 1.2 million in properties and he called in because his bank would not extend anymore credit to him.
I explained to his that he should start purchasing properties through his LLC and not using his own credit.
Sure enough it worked! He said he probably knew that but did not think of it till I mentioned it.
You may also want to set up a business entity within your state. This can be along with your LLC a tremendous tax benefit for you.
Randy
Other than setting up the LLC is there anything else that needs to be done. Are we required to prepare "Article of Corporation" )I think that is what it is called)?
Can you explain what you meant about also setting up a business entity? I thought that the LLC was the business entity.
Thanks.
Always striving to move forward toward better times!
Verna (newage8767)
Sorry, It's called Articles of Organization"
Always striving to move forward toward better times!
Verna (newage8767)
Hi Verna,
I like many have questions and sought out answers I chose to use Legal zoom. For two reasons (I am not advocating or promoting them, just sharing my experience) one they have a payment structure of three monthly installments, my L.L.C. In my home state ( New York) cost me around $750.
Here is why;
I have a registered agent for a year that receives any legal notice that needs to be made aware to my company.
I have a business compliance package that I opted into, and by having this I had tax proffessionals who will address my questions if need be, the only catch you have to book a phone consultation.
They set up my articles of organization.
My member minutes and examples and extra sheets.
They created my EIN number ( Employee Identification Number) [ this is form SS-4 for IRS purposes]
They filed everything with the state on my behave.
I have a company seal (trademarks / copyrights is an extra expense you may want to take)
I have business forms that came with my package.
I have an operating agreement
I have membership certificates
I have membership ledger
----------------
You also have a free website that comes alongside setting up your business entity with them.
And Dun & Bradstreet Credibility corp (which monitors your business credit )
The benefits are abundant. I was coaching one of my clients that had purchased 1.2 million in properties and he called in because his bank would not extend anymore credit to him.
I explained to his that he should start purchasing properties through his LLC and not using his own credit.
Sure enough it worked! He said he probably knew that but did not think of it till I mentioned it.
You may also want to set up a business entity within your state. This can be along with your LLC a tremendous tax benefit for you.
Randy
Other than setting up the LLC is there anything else that needs to be done. Are we required to prepare "Article of Corporation" )I think that is what it is called)?
Can you explain what you meant about also setting up a business entity? I thought that the LLC was the business entity.
Thanks.
Watch your thoughts, for they become words.
Watch your words, for they become actions.
Watch your actions, for they become habits.
Watch your habits, for they become character.
Watch your character, for it becomes your destiny.
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Our Heart's Desire must be nurtured by our mind,to give birth to common sense, that will enable us to seek out the path less traveled, with the greatest Personal Growth. -J.R.-
However there are additional requirements I found out
For example I have to publish in two newspapers.
One being The New York Law Journal (this is mandatory you can not avoid this) this publication cost $750 alone,
I know ouch.
And a second newspaper of my choice according to the county clerks office of list of newspapers they have.
I am publishing in the second newspaper which only cost me $180
I believe I only have 120 days from incorporating, to complete this or my business activities are suspended until I complete such task
Then file both affidavits with the Secretary of State with a minor fee of $50
Business incorporation is very important not only for legal but tax purposes,
As is the example Robert Kiyosaki explains most in the E/S quadrant do not cross into the B/I side and do not enjoy the same privileges as they do.
Hope I was helpful and thanks to the original poster for bringing this to our attention
Watch your thoughts, for they become words.
Watch your words, for they become actions.
Watch your actions, for they become habits.
Watch your habits, for they become character.
Watch your character, for it becomes your destiny.
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Our Heart's Desire must be nurtured by our mind,to give birth to common sense, that will enable us to seek out the path less traveled, with the greatest Personal Growth. -J.R.-
I was planning to file online for am LLC with only myself as a member. In your initial post you stated that a LLC that elects to be treated as a corporation is the best choice in most states. Then 2 paragraphs down you say that LLCs are the most flexible and that Corporations have various restrictions on who can be an investor, what kind of income can be earned as an investor, etc. So, I'm not understanding why we would want the LLC to be treated as a corporation tax structure? Seems as though I missed something here.
Btw, thanks for this information.
Always striving to move forward toward better times!
Verna (newage8767)
Not for a couple years anyway!
www.tw4homes.com website
https://tvallc.isrefer.com/go/RehabLite/reigirl/ FREE SOFTWARE FOR WHOLESALERS, REHABBERS AND AGENTS! Present professional looking deals to buyers and lenders as well as run your numbers and get the ROI.
Called, "Start Your Own Corporation," by Garrett Sutton. This talks all about entities and the pros and cons of each. I would find a RE CPA otherwise to answer your questions regarding the tax aspect of each.
www.tw4homes.com website
https://tvallc.isrefer.com/go/RehabLite/reigirl/ FREE SOFTWARE FOR WHOLESALERS, REHABBERS AND AGENTS! Present professional looking deals to buyers and lenders as well as run your numbers and get the ROI.
Thank you for the recommendation. I will check it out.
Always striving to move forward toward better times!
Verna (newage8767)
I second that book and any other book by the rich dad advisors
Watch your thoughts, for they become words.
Watch your words, for they become actions.
Watch your actions, for they become habits.
Watch your habits, for they become character.
Watch your character, for it becomes your destiny.
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Our Heart's Desire must be nurtured by our mind,to give birth to common sense, that will enable us to seek out the path less traveled, with the greatest Personal Growth. -J.R.-
you have done a couple deals and then consult RE Attorney & Accountant
Mike
https://tvallc.isrefer.com/go/RehabLite/renvestr/ Free tools
This is helpful info for a beginner just starting out. thank you
- think about what if? - and what is possible rather what is not![Smiling Smiling](http://mail.deangraziosi.com/modules/smileys/packs/example/smile.png)
- Kevin
You can Join my Buyers list: http://www.townlineproperties.com
thanks Mike, Great advice on when to set up new entity. I was wondering about if I should set up an LLC or S corp prior to doing any deal or after I get things going.
- think about what if? - and what is possible rather what is not![Smiling Smiling](http://mail.deangraziosi.com/modules/smileys/packs/example/smile.png)
- Kevin
You can Join my Buyers list: http://www.townlineproperties.com
This really was a great info for a beginner. I really liked the article on this topic page.
- Torn, personal assistant David Lichtenstein
Anita I was reading about John this morning on this same subject, he is pretty knowledgeable really like what he tells us, many thanks, Jim
jbischoff