Avoiding Self Employment Taxes

[Kyle B.]

I wanted to see if anyone has been able to (legally) avoid paying self employment taxes on the profit from their flips. I met with an accountant and he said I would have to pay a 15% tax for self employment - essentially the 7.5% an employer would withhold for social security, medicaid, etc. as well as the 7.5% contribution an employer makes on their employees behalf. 

I asked if it were possible to categorize the profit from a flip as a short term capital gain, therefore avoiding the 15% tax, but he said that it wasn't possible given the fact that it was not a passive investment - essentially I've established this type of work/investing as my primary job and was actively involved in it.

I just wanted to see if was possible to avoid this tax at all or if it is some thing I will always have to anticipate.

Thanks,

Kyle

[Brandon Hall]

Flipping houses is not a passive activity. The houses are essentially your inventory and you are operating a full blown business rather than "investing."

That being said, you can drastically reduce your SE taxes by flipping houses in an S-Corp. An S-Corp allows you to pay the owner a "distribution" as well as a "reasonable salary." Distributions are taxed at your ordinary rate and will not be subject to SE taxes while the salary you pay yourself will be subject to SE taxes.

Example: S-Corp generates $100k and you estimate that a reasonable salary for someone in your profession and area is $60k. You classify $60k as a salary and $40k as a distribution. The salary is subject to SE tax while the distribution is not. You have effectively decreased your SE tax liability by 40%. **Note that there is a bit more that goes into this, but think of this as a high-level example for your general understanding.

I'd also like to note that S-Corps can be costly to establish and operating. You will need an accountant/tax planner, lawyer, etc. Depending on the caliber of property you are flipping, you may be better of sticking with an LLC and paying the SE tax.