Sorry… - Posted by JHyre in Ohio
Posted by JHyre in Ohio on June 21, 1999 at 19:36:53:
that is too short with too little detail because I’m a teesey bit busy. Meant to answer the “Steve Cooke, Inc.” post & didn’t for the same reason. Here’s a quick and dirty:
Multiple related corporations are likely to be classified as one corp by the IRS, especially if the business conducted by each is identical or heavily inter-related. This means ONE $50,000 15% bracket for ALL/MOST of your incorporated businesses. If this were not the case, I could create a new corp for every $50k in income and never pay over 15% in taxes. There is no bright line in terms of how close the business relationship must be between each corp to attract reclassification as one corp. For example, a buying corp and related corp may or may not be reclassed as one corp- depends on all the facts and whether the IRS agent has recently engaged in nocturnal activity of the more pleasant sort. In fact there is no statate that I no of that specifically addresses this situation. There is a nasty and VERY broad one in the form of IRC 482. IRC 482 basically allows the IRC to reclassify transactions if a tax-avoidance purpose is involved. Way broad, subject to the ever objective and reliable judgment of the IRS. This statute has been used to reclass lots of different transactions. I believe that it would be successfully to avoid creation of too many 15% brackets with multiple related corporations. So as a general rule, lots of related corps are setting one up for a possible fall.
Before the question of multiple corps ever comes up, one must consider this question: Why use a corp at all? Here’s the situation where a corp is useful:
ACTIVE business that REINVESTS earnings at a HIGH RATE and can create enough DEDUCTIONS to keep income below $50,000 to $100,000. Specifically:
ACTIVE- because too much passive income in a corp makes a Personal Holding Company. Without going into the gories, rest assured that being the owner of a PHC is alot like dropping a bar of soap in a room full of convicts.
REINVESTS- if earnings are being directly distributed, you are being double-taxed. By definition, double taxation is worse than single taxation if the rates for each are comparable. See prison shower room analogy (latter word is not intended as a pun).
HIGH RATE: Assuming that some double taxation will eventually occur means that we are playing a present value game. We eat the low 15% rate now and another tier of taxation later on at least some income because paying 15% now + HIGH COMPOUNDING more than makes up for any tax on dividends that are eventually distributed. If rate of return is “low”, there’s not a lot of compounding and the present value of after-tax distributions would have been higher paying a SINGLE high rate now (i.e.- using an LLC) than paying a low rate now and a second higher rate much later, as is the case with a corporation.
DEDUCTIONS: If you cannot keep the corporation’s rates in the 15% bracket (or 25% bracket if you have very high personal rates), the initial tax is as high or higher than what the SINGLE LLC tax would have been. Add just the potential for a second tax and you WILL lose the present value game as a matter of mathematical cetainty. Once you have HIGH INCOME and cannot keep it down with deductions (Kiyosaki uses as much depreciation as possible, but as he said, he can’t get enough of it), it’s time to convert the C-corp to an S-corp or LLC or sell the shares if they are REALLY liquid (Like NYSE listed & no thin trading- Yours won’t fall into that category).
Passive holding is best in LLC because in C-corp:
Appreciation is taxed at higher rates (personal capital gains rates are much lower than corporate) twice. Also, passive income can turn C-corp into PHC. Other factors…rate of return, reinvestment, deductions…mentioned above of course factor in. Ultimately, the best way to do this is put a pencil to it. If you’d like to present mock figures, I will address them as time permits…probably on a weekend.
Re what successful people use- SCALE MATTERS. The ability to shift overseas, have access to public capital (and I mean major-exchange listing) and hire legions of professionals changes the nature of the game. Even then, many C-corps would love to NOT be C-corps- problem being, the price of exiting corporate solution is VERY high in most cases.
NOT ALL successful people use corps and certianly not for EVERY line of business. I have NEVER seen that, but I’ve seen lots of successful people. I’ve also NEVER seen someone with a corp that has the primary purpose of holding passive assets. I see few small businesses held in corporate solution, although some of those change to corps when conditions warrant (e.g.- scale). I really think that imitating successful people without knowing that you are in the exact same situation- type of business, scale, etc- is not a good idea. I’m with your partner- know WHY you are using a given structure. Put a pencil to it- in other words project the numbers and plan accordingly.
In the future, I would love to write a comprehensive piece on this. Even if I find the time to do all of the research, it’d still end up being a book. I apologize for the disjointed, cursory and incomplete nature of this post…sadly, to do more impinges on other priorities at this time. Based on what I’ve seen at the Big Five, in corporate America and doing a little side work, corporations work in the situations I described above and are a massive burden in others…let me repeat- NOT ALL successful people use corporations for every circumstance…one size does NOT fit all. Time permitting, I will happily expound in manner understood by speakers of the English language. Bear in ming that changing INTO a C-corp is alot easier and MUCH cheaper than converting OUT of one.