Good morning everyone, I hope everyone is having a great day. I was wondering from an entity, tax and brand perspective. Is it best to be an LLC or S Corp when your wholesale flipping? I'm strictly assigning the deal over to another investor. Any suggestions? Thanks!
As I understood from a conversation I had with a CPA this morning, UNDER the LLC structure, if the company has more than 1 partner, you can opt for Partnership LLC or S Corp.
As an S Corp under the LLC, you can choose to declare whatever amount you want as self-employment tax, where as the Partnership LLC, requires all partners to pay full self-employment based on your shares of the company.
A property under my SCorp LLC (with two partners 50/50 ownership) that made 10K total profit (after deductions, depreciation, expenses, etc) would allow me and my partner to only pay 1k (any amount for that matter) each of self-employment tax if we wanted to, leaving 8k untaxed (by self-employment tax) in the company account.
A property under my Partnership LLC (with two partners 50/50 ownership) that made 10K total profit (after deductions, depreciation, expenses, etc) would require that each of us pay 5k self-employment tax. No choice.
Can anyone else confirm this or give feedback?
Troy is on the right path for the S-Corp. The key is the compensation "self employment income per se" has to be reasonable according to the IRS, so it's not quite whatever you want. One of the biggest audit risks of an S-corp is the reasonable compensation piece as the IRS understands people use it to skirt SE tax. Also, the income does not have to remain in the Corp, it can come out in the form of distributions not subject to SE Tax.
In a simplified manner I also agree with Troy regarding partnership taxation and the implementation of SE Tax for all income to all partners, however there are situations where investment partners may not be subject to SE Tax. Fairly complex rules govern this.
As a CPA, I generally push my clients to the S-Corp for a flipping entity, especially if they are going to perform multiple flips in a year. It's just another tool we use to control SE Tax at the end of the year.
Yep, if you make $100k showing only $10k as a “reasonable” salary is going to be tough.
Thanks for the info Justin,
A few questions if you don't mind.
How do you decide how much to "shield" from taxes and how much to pay yourself? I know that's probably going to be relative, but just asking in general terms. Does the SE income have to be a regular income or can it be a percentage of each deal (in the case of a wholesale business). Do the payments have to be timely? (i.e. once each month, quarterly etc.)
Where is the money that is not subject to SE tax kept if not with the Corp?
I've also heard some people recommend placing some properties in their own Corp or LLC for liability protection. Can an S-Corp own other entities as an asset?
@Justin Freeman made some pretty solid points re: benefits of an S Corp. I'd like to add in a note or two...
Before the passing of the TCJA, Justin's statements were pretty widely accepted - generally speaking, S Corps were the way to go for active businesses like flipping and wholesaling to help mitigate SE tax.
Now, with the new tax law in effect, the Section 199A 20% QBI deduction throws a wrench into the plans.
There are already a few great threads about the Section 199A deduction on the forums, so I won't beat a dead horse on that but I will say that it certainly should make everyone rethink their entity structure.
If you fall below the income threshold for the QBI deduction ($157,500 for single filers; $315k for married filing jointly), it might be more beneficial to forego the S Corp. Why? Because you are required to pay yourself wages in an S Corp, which reduces QBI and, therefore, the 20% deduction.
For example, let's assume two single taxpayers with the same amount of gross flipping income ($100k); one owns an S Corp and the other an LLC. Each has expenses of $20k. The S Corp owner, however is required to draw a salary (let's assume $45k). The S Corp owner's QBI would be $35k ($100k - $20k - $45k), resulting in a deduction of $7k ($35k x 20%).
The LLC owner, however, would have QBI of $80k ($100k - $20k) since there is no wage requirement. This results in a much higher QBI deduction of $16k ($80k x 20%).
If you're over the income threshold, it gets even more complicated.
Obviously, every scenario is different and you should consult your CPA but it's definitely some food for thought!
@Nicholas Aiola, you make some great points about the new 199A deduction. We've started talking to clients about this point exactly. I agree every situation is different, but we've found especially at higher incomes, the SE Tax savings moving to the S-corp still seems to be too much to cover even with the 20% deduction. At lower income thresholds, I agree it gets much closer, but you worry about a year that pops.
For example, net income before wages is 100k. As a single member LLC I pay, let's say 11% net for SE Tax after the deduction for taxes. So SE Tax is 11k + taxes on 80k of income (100k-20% 199A deduction).
If I'm an S-Corp and take a 40k wage. My payroll taxes, again net 11% are 4,400. My income tax is based on income of 88k ((100k-40k)×80%)+40k taxable wages.
At those numbers it's hard to offset the SE tax with the reduced deduction. The key is going to be getting wages as close to 40% of QBI as possible so we don't limit the deduction or reduce it too much, that's going to be the biggest planning piece this fall is getting wages where we need them especially in single owner, single employee businesses.