Should I have my LLC taxed as an S-Corp?
Investor · Vestal, NY · Member since 2016 · 59 posts · 35 votes
I've created an LLC in Broome County, New York. It's time to decide whether to leave it as pass-through taxable or choose to have it taxed as an S-Corp. My plan is to use the entity to hold my buy & hold property. One to start. I'm right now, scaling my portfolio from 1, up to 3 properties. The LLC will hold 1 / 3. Can/Should I receive rent payment from properties NOT held in the LLC, using the LLC? I want to close on two more properties by June 2017. If my aim is to scale the business now and use a cash flow generating model to do so, am I better off filing for the S Corp?
Additionally, as I seek deals to buy more property, is is wise to use the LLC name in my marketing efforts? Any reason not do so? I was thinking that since my LLC is generically named that maybe my marketing efforts would be more successful using a flashier DBA name.
Thanks again @Meagan Barkley. This is good stuff and pardon me if I'm still not getting it. So do you agree or disagree with this: Seems to be contrary to your assessment. I read this to mean (1)that I'd be taxed normally on wages I pay myself. (2) I'd be taxed less (dividend rate) on wages received from rental income.
A key feature of the S corporation is its ability to minimize overall tax liability for you and your business. Because of its nature as a corporation, only the wages paid to its owner/employees are earned income subject to FICA tax for Social Security and Medicare. Other net earnings that pass-through to the owners are considered dividend income. This means those payments not subject to SECA tax and—provided the shareholder material participates in the business—they are not considered passive income.Thus, an S corporation can do some tax planning that can not be accomplished in a typical LLC.
Hubby & I have two LLCs. One holds our rental properties and is simply a disregarded entity, the other is for a different business and is taxed as an S corp, so I have practical experience with the differences.
First the S corp. This business rents the building it occupies from our properties LLC. This is an expense to the S corp and income to the LLC, but is passive income rather than earned income. This is an important distinction. We take $x per month as wages and an equal amount as distributions. FICA & unemployment taxes must be paid on the wages, but not the distributions. It files its own tax return (deadline March 15) but the return is only informational. Any income the S corp has is passed through to our personal taxes, but is not subject to self employment tax (FICA) as it would be without the S corp status.
Income from the LLC that holds the properties is also passed through to our personal taxes, but there is no additional return required. This is passive income, not subject to SE tax. This company does not pay us wages, since we can take any amount we choose as distributions.
So this is what our tax picture looks like:
Those, along with anything else on lines 7-21 make up our total income. There is no difference in rates on the 1040 between W2 income and profits from an S corp or rentals. The difference is the FICA and unemployment taxes. Every dollar you can move from W2 income to passive income saves you well over 16%. I like that kind of return!
Hello David,
Great questions! I would say from experience as I currently have an LLC it would be wise to stick with that as it may offer you more protection personally if you get sued. Please inbox me if you would like to speak further about this.
Kevin
You generally don't want to hold rentals in an S Corp. See the passive income restrictions section.
http://smallbusiness.chron.com/s-corporation-passive-income-restrictions-76870.html
@Meagan Barkley thank you. I do not intend to hold the property in an S Corp. I already have the LLC but my understanding is that I may choose to have the LLC taxed either as a C, S or Pass through (the default option).
Really, what I'm trying to figure out, is whether or not I elect to have the LLC treated as an S Corp in order to avoid double taxation on income & profit while gaining shelter for business expenses I'd presumably spend my profits on in the same tax year. There's a distinct difference there. Not sure if that's the same thing this article refers to.
If you are interested in further isolating the the distinction, which among BP contributors there seems to be a lot of confusion, I just read a good article. It's leading me to believe that I can avoid tax disadvantages by treating my LLC as an S Crop...Here's a line: " ...A key feature of the S corporation is its ability to minimize overall tax liability for you and your business. Because of its nature as a corporation, only the wages paid to its owner/employees are earned income subject to FICA tax for Social Security and Medicare...." BizFilings S-Corp/LLC Article
@Kevin Maxwell thanks! Not sure I explained my question well enough. I'm not planning on changing the entity, I'm wondering whether the way my LLC is treated for tax purposes is better left as 'pass-through' meaning earnings will be taxed at my individual income bracket or whether I should elect to have my LLC treated as a S Corp, which is an option that's been presented to me. I'd love to connect with you offline, however, so look for my PM. Thanks again!
Even if it's an LLC legally and taxed as an S Corp, the passive income issue will still be an issue. S Corps are only beneficial for active income (like flipping). If you are an LLC and elect to be taxed as an S Corp with rental real estate only, you will be penalized by paying the highest tax rate. The S Corp allows you to control SE tax, and SE tax isn't due on rental real estate. I think people are confusing legal status and tax status. Partnerships and S corps are both pass through entities for tax purposes, either one will be taxed at your personal bracket.
Thanks again @Meagan Barkley. This is good stuff and pardon me if I'm still not getting it. So do you agree or disagree with this: Seems to be contrary to your assessment. I read this to mean (1)that I'd be taxed normally on wages I pay myself. (2) I'd be taxed less (dividend rate) on wages received from rental income.
A key feature of the S corporation is its ability to minimize overall tax liability for you and your business. Because of its nature as a corporation, only the wages paid to its owner/employees are earned income subject to FICA tax for Social Security and Medicare. Other net earnings that pass-through to the owners are considered dividend income. This means those payments not subject to SECA tax and—provided the shareholder material participates in the business—they are not considered passive income.Thus, an S corporation can do some tax planning that can not be accomplished in a typical LLC.
Check out these books from Mark Kohler:
https://www.amazon.com/s/ref=nb_sb_noss_2?url=sear....
https://www.amazon.com/s/ref=nb_sb_noss_2?url=search-alias%3Daps&field-keywords=mark+kohler
I think it bears mentioning that there seems to be a virtual 'order of operations' required in order to have rental income treated as passive. That order begins with that income 'appearing' normal but through the S Corp, being distributed as dividends, therefore treated as passive. In addition, I think that income, as a function of the 'Corporation' can also go into expenses which would essentially be tax sheltered from that angle too.
Thanks again @Meagan Barkley. This is good stuff and pardon me if I'm still not getting it. So do you agree or disagree with this: Seems to be contrary to your assessment. I read this to mean (1)that I'd be taxed normally on wages I pay myself. (2) I'd be taxed less (dividend rate) on wages received from rental income.
A key feature of the S corporation is its ability to minimize overall tax liability for you and your business. Because of its nature as a corporation, only the wages paid to its owner/employees are earned income subject to FICA tax for Social Security and Medicare. Other net earnings that pass-through to the owners are considered dividend income. This means those payments not subject to SECA tax and—provided the shareholder material participates in the business—they are not considered passive income.Thus, an S corporation can do some tax planning that can not be accomplished in a typical LLC.
Hubby & I have two LLCs. One holds our rental properties and is simply a disregarded entity, the other is for a different business and is taxed as an S corp, so I have practical experience with the differences.
First the S corp. This business rents the building it occupies from our properties LLC. This is an expense to the S corp and income to the LLC, but is passive income rather than earned income. This is an important distinction. We take $x per month as wages and an equal amount as distributions. FICA & unemployment taxes must be paid on the wages, but not the distributions. It files its own tax return (deadline March 15) but the return is only informational. Any income the S corp has is passed through to our personal taxes, but is not subject to self employment tax (FICA) as it would be without the S corp status.
Income from the LLC that holds the properties is also passed through to our personal taxes, but there is no additional return required. This is passive income, not subject to SE tax. This company does not pay us wages, since we can take any amount we choose as distributions.
So this is what our tax picture looks like:
Those, along with anything else on lines 7-21 make up our total income. There is no difference in rates on the 1040 between W2 income and profits from an S corp or rentals. The difference is the FICA and unemployment taxes. Every dollar you can move from W2 income to passive income saves you well over 16%. I like that kind of return!
I'm leaning toward going the route of an LLC with S Corp election for flipping and setting up a separate LLC for buy and hold rentals (but haven't analyzed the S Corp election for the rental side). The initial plan is to pay a small "reasonable" salary and to take out anything else as dividends. My wife and I are also setting up a 401(k) within the LLC for the ability to put away more tax deferred and for the ability to borrow against it. I meet with tax planners after their Oct. 15 rushes so may come away with different preferences later.
If you do go with the S Corp election, don't just check the box and proceed. Many boilerplate operating agreements for LLC's will probably fail to qualify for S Corp taxation because many fail the single class of stock requirement. If you elect S Corp treatment, make sure that you have someone familiar with that issue review your operating agreement to make sure that you qualify to reduce the risk of losing the S Corp treatment after the fact and getting hit with back taxes and penalties.
Andrew, thanks for the lead on the Kohler books. I just ordered one and look forward to moving a little further along the learning curve.
@Sylvia B. Thank you Sylvia! That was exactly the information I was looking for. And thank you to everyone else who contributed! What a fantastic resource this is.
@Mark Rogers Thank you. Can you elaborate on the 'single class of stock' piece a little further? If I am the sole member for the entity, is that less of a concern? Or, are the considerations based more (or any) on distribution. I'm not clear on how or what actions would affect the single class of stock clause.
That should be less of a concern if you are the sole member. Here is a good article discussing the issue: http://www.wnj.com/Publications/Common-pitfalls-to-avoid-when-converting-an-LLC-in
@David drew, Have you considered consulting with your local CPA or even one from NYC? It should also be one who participates real estate investing.
That would be the most appropriate place if i were you.