Best Business Entity for My Flipping Business?

Question

Hello everyone! I am getting myself more and more confused with each thing I read regarding which business entity is best for me. So here’s my situation..

I am about to graduate college and will be working in my field full time in order to be approved for a mortgage and financing to pay for renovations for my first flip. I am pretty handy and plan on doing a lot of the easier work myself, and I may try to get my contractor’s license (apparently very easy to get in NJ) to make things a bit easier as far as permits are concerned. Aside from a down payment on a home and money I can afford to take from my weekly pay, I will be probably paying for most things on credit for the first flip. My sister wants to get involved and will be helping by assisting me in whatever reno projects we can do ourselves (probably just painting, tiling, flooring, and basic stuff to save on labor) and by letting me use her good credit for finance options.

I’m hoping within 12-18 months, I will be able to quit my 9-5 and do this full time. I’m trying to be realistic and figure 2-3 flips in that period is attainable. My concern is taxation. Won’t I get killed with taxes at the end of the year if I make, say 100k from these properties since they’ll be treated as short term? Isn’t the tax rate over 30%? Would setting up an LLC be the smartest route tax wise? I would like to be able to pay salaries to both me and my sister so that we have verifiable income once I leave my 9-5 job. I’d also like to avoid paying the government nearly 40% of my take-home, especially because I’ll be putting so much time and work into these properties myself. Any suggestions? I’ve been researching this stuff for nearly 3 years now. I’ve been learning how to do different reno projects from watching and assisting in work being done in my parents house, watching shows on tv to learn some tips, shopping online for materials and learning the costs to get them done and installed, I have created a few extremely detailed budgets to familiarize myself with costs, I’ve studied a few areas I’m interested in and have been following their markets for years, and reading articles on different aspects of the business. I love diy and interior design and I would love to own a business, so it makes sense that this would be the career for me. I am just having A LOT of trouble understanding which business entity would work best for me and how to avoid being blindsided when tax time comes around. I guess I should’ve listened more in my business law and accounting classes! Any help and advice would be greatly appreciated!!!

Eamonn McElroy · Answer

@Ashley A Merk "My concern is taxation. Won't I get killed with taxes at the end of the year if I make, say 100k from these properties since they'll be treated as short term? Isn't the tax rate over 30%? Would setting up an LLC be the smartest route tax wise? I would like to be able to pay salaries to both me and my sister so that we have verifiable income once I leave my 9-5 job. I'd also like to avoid paying the government nearly 40% of my take-home, especially because I'll be putting so much time and work into these properties myself. Any suggestions?"

If you're expecting $100k net in year one it's well worth it to add a tax CPA/EA to your team of external partners.

An LLC with an S election might be the most advantageous avenue to pursue.

You would have to pay all employee-owners 'reasonable compensation'.  Your sister could be added on as a non-equity employee and issued a W-2 salary for services provided.  Sec 199A deduction might come into play for you as well on your personal tax return.

Seems like it might accomplish much of what you want.  Best to talk to your CPA/EA who knows your exact facts and circumstances and can lay out all the options.

Eamonn McElroy · Answer

Analysis with actual numbers or projected numbers is required.  It also very much depends on what 'reasonable compensation' is for the owner-employee, which sounds like it would be just you initially.  Reasonable compensation needs to consider all the facts and circumstances surrounding both you and the business.  There's no general rule or percentage like most people throw out.

I generally advise my clients that S Corps don't start to make sense until around $50k of net taxable.  It's really a wash at that level considering you're adding the overhead of administering a corporation for tax.  $60k you start seeing material savings.  Again, this is an analysis that needs to occur with a CPA or EA as it's highly case specific.

It might be best to start off with the default SMLLC tax status of 'disregarded entity' and later make an S election further down the road.  Can still pay your non-owner sister a salary or wage in this situation.

Very good convo to have with your CPA/EA.

Ashley A Merk · Answer

Great advice thank you so much!!! I will have to find one in my area to work with. Appreciate your time!!!

Ashley A Merk · Answer

Would you still recommend doing the llc as an s Corp if the expected profit was lower? What if it was more along the lines of $50-75k? Thank you so much for your advice!! I’m pretty sure LLC taxed as an S corp is the way to go from what I’ve been reading.