Please explain advantage of S-corp for flipping - Posted by Chie

Posted by Chie on January 18, 2002 at 13:38:47:

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Please explain advantage of S-corp for flipping - Posted by Chie

Posted by Chie on January 18, 2002 at 08:33:32:

After reading many articles/postings, I am still not sure the advantage of S-corp over LLC for flipping. My understanding is that the nature of the transactions determines dealer status, not the entity they operate in. Or is it something like LLc can’t be used for dealers?

Please help!! I will be a dealer and am trying to decide the best entity to start.

Chie

Re: Considering C corp instead of S-corp - Posted by del

Posted by del on January 23, 2002 at 17:47:36:

I’ll jump in here for a minute.
While S corp gives you a pass-thru to the individual (singlelevel) for taxing, One might consider the fact that an S corp status does not allow one to take full advantage of business tax deductions available to offset gross income like a C corp can. S corp -NO privacy for sure as to your business dealings as S corp ownership plainly on the public record. C corp can also offer more privacy depending on how and where it is structured and set up. just my 2 cents worth to consider.

Re: Please explain advantage of S-corp - Posted by JT-IN

Posted by JT-IN on January 18, 2002 at 10:19:15:

Chie:

Flipping RE, and being considered a dealer by IRS, does create ordinary income. If you are doing so as a sole proprietor, then all income, is subject to FICA, (up to the maximum) or Self-Employment Tax, and the Medicare deduction.

However, if doing this activity as an S-Corp, you can pay yourself a “reasonable” salary, which is subject to FICA, and medicare deduction only on the salary amount, with all profits over and above that salary being considered a dividend. No FICA or medicare deductions are paid on dividends.

Let me give you an e.g. below:

Let’s say you earned 100K net, as a RE investor, NON-INCORPORATED ENTITY, with no other W-2 income. (Figures are based on 2001 SE Tax limit of 80,400; this increases to 84,900 in 2002)

Then the the first 80,400 of profit is subject to a 12.4% SE Tax; or $ 9969.70, with all earnings over the maximum cutoff of 80,400, in this case being 19,600; subject to a 2.9% medicare tax; that amount of tax would be $ 568.40. Your total SE Tax and Medicare tax on this income would be $ 10,538.10

Now, lets do the same income $ 100K, as an S-Corp, with you receiving a $ 30,000 salary, and $ 70,000 in dividend. The salary would be taxed at a combined rate for employer and employee of 15.3%, or $ 4590. No SE Tax or medicare tax on the dividend of $ 70,000; so the net savings in SE and Medicare taxes, to an identical S-Corp is $ 5948.10

Hopefully this step by step will help you understand the benies of an S-Corp. There are many variations and nuances.

Then there is the comparison between the C-Corp and the S-Corp, but we will leave that for a whole another conversation. Personally, I do flip property, and I use the S-Corp as my business entity.

JT-IN

Okay - Posted by The Baze

Posted by The Baze on January 18, 2002 at 09:53:30:

The nature of the transaction does determine whether the property is dealer property or investment property. However, what you’d prefer to do is to separate the dealer side of your business from the investor side of your business. Separate entities is a way of doing this. You can have an LLC or an S-corp hold your rentals, while a C-corp does the flips. You do NOT want to hold rentals in a C-corp.

If it were me, I’d put the rentals in an LLC, and set up a C-corp w/ a March 31 year end to do flips. Let the corp pay your salary and non taxable fringe benefits in order to reduce the taxable income to as close to zero as possible. This way you make some smack, enjoy some perks, and if you’re smart, fund your retirement heavily.

Hope this helps.

Tom Bazley, CPA

S-Corp… are you sure? - Posted by RicCrouch

Posted by RicCrouch on January 18, 2002 at 18:37:02:

You sure about the way you describe this, JT? If I am not mistaken, an S-corp is not a separate entity for tax purposes… you said,

"Flipping RE, and being considered a dealer by IRS, does create ordinary income. If you are doing so as a sole proprietor, then all income, is subject to FICA, (up to the maximum) or Self-Employment Tax, and the Medicare deduction.

However, if doing this activity as an S-Corp, you can pay yourself a “reasonable” salary, which is subject to FICA, and medicare deduction only on the salary amount, with all profits over and above that salary being considered a dividend. No FICA or medicare deductions are paid on dividends."

However, according to “How to Incorporate and Start a Business in Georgia”, page 12:

“The result of filing this [Subbchapter S election] form is that a corporation is no longer treated as a special entity for tax purposes. Instead, all of the profits and lossess will flow directly to the shareholders, as in a partnership.”

If you are therefore the only shareholder (or you and your wife, as in our retail business) the income is treated as individual income, and the dividends are not double taxed as are dividends from a C-corp.

Anyone else more knowledgeable than myself out there know more about this?

Ric

are there any limitations on dividents - Posted by sean mcguinness

Posted by sean mcguinness on January 18, 2002 at 14:01:23:

hello. refering to your example of the dividents from the corporation, are there any limitations on the use of those dividents?thanks

~Sean

JT-IN, thanks for your advice!! Question… - Posted by Chie

Posted by Chie on January 18, 2002 at 13:11:40:

In your example, you used salary of $30,000 and dividend of $70,000, and it sounds great. One concern… Would IRS be OK with this? I thought IRS wouldn’t like too much paid out as dividend and try to reclassify as salary. I just want to be sure it works siiiince it does sound like a good idea. I appreciate your help. Thanks again,

Chie

Re: Please explain advantage of S-corp - Posted by Dave (CA)

Posted by Dave (CA) on January 18, 2002 at 10:52:24:

If you have a full-time job that is not real estate related, would you still have to pay self employment tax on your RE earnings?

Re: Please explain advantage of S-corp - Posted by JHyre in Ohio

Posted by JHyre in Ohio on January 18, 2002 at 10:31:15:

EXCELLENT explanation! Thanks for saving me the trouble! Want some work? Tax season is upon us, LOL!

John Hyre

Re: Okay - Posted by sean mcguinness

Posted by sean mcguinness on January 18, 2002 at 14:09:04:

hello! why would you prefer a LLC corp for rentals and not an S cor? why wouldnt you want to set up a c corp for holds? what did you mean when you said, “set up a C-corp w/ a March 31 year end to do flips”? hope you can clarify these questions for me. thanks

~Sean

Thanks for your advice!! Questions… - Posted by Chie

Posted by Chie on January 18, 2002 at 12:51:28:

What is the specific reason for picking March 31 year-end? Why would you rather set up C-corp over S-corp? I appreciate your help!! Thanks again,

Chie

Re: S-Corp… are you sure? - Posted by JHyre in Ohio

Posted by JHyre in Ohio on January 19, 2002 at 04:27:22:

While an S-corp does pass through income, it is in many ways a separate entity or person for tax purposes…that’s why it can pay you a salary, for example. The same applies to partnerships, albeit to a lesser degree. There’s a good body of tax case law describing when the entity theory (separate person) or aggregate theory (same person) applies.

John Hyre

Re: S-Corp… are you sure? (YES) - Posted by JT-IN

Posted by JT-IN on January 18, 2002 at 22:03:22:

Ric:

Let me answer your last question first: “Anyone else more knowledgeable than myself out there know more about this?”

Yes, that would be me! Not to be a smart azz, but exactly how I described it, and exactly what you cited from the GA pamphlet, do mean exactly the same thing.

Let me further explain here…

The flow-thru feature of the S-Corp, of profit or loss that you referred to, does not distinguish between salary or dividend, because this portion is referring only to the payment of federal income taxes… based upon your aggregate marginal tax rate. The part about dividends not being double taxed simply means again, that they are taxed at you aggregate marginal tax rate. Conversely, if it was a C-Corp, the corp would pay tax, at it’s own rate, then based on what is distributed as earnings, would then be taxed at your marginal rate. The flow-thru feature of the S-Corp eliminates this double taxation.

None of the above description, is dealing with the issue of FICA or medicare tax, but solely the marginal income tax rate that you pay as an individual, exclusive of FICA or medicare. These are two entirely different matters, but do appear on your 1040.

Let me more specific here: From page 9, of IRS Pamphlet 533; on SE Tax it states the following:

S Corp. Shareholder and Officer… If you are a shareholder in an S Corp, your share of the corp’s earnings, are NOT subject to SE tax, even though you include this in your gross income for income tax purposes.
If you are a shareholder and also an officer of an S-Corp, and perform substantial services, you are an employee of the S-Corp. Your payment for services is subject to withholding of social security and medicare taxes and is not subject to SE tax, regardless of what the S-Corp calls the payment.

Now, what this says is; the payment for services is salary, and subject to FICA and medicare tax, while the above mentioned corp’s earnings, aka DIVIDENDS, is not subject to FICA and medicare taxation.

Now, if you want to check the above info, check with the “Walking Tax Code”, aka John Hyre, Esq. You can reach John at jhyre@bright.net It is no coincidence that John’s ISP’s name is BRIGHT !

JT-IN

Re: JT-IN, thanks for your advice!! Question… - Posted by JHyre in Ohio

Posted by JHyre in Ohio on January 18, 2002 at 13:34:26:

Depends upon whether the salary is “reasonable” given all of the “facts and circumstances”. I would figure out a way to justify a low salary…for example, what does the average realtor make per year? Not much! Of course, the average realtor probably only closes a few deals…so many facts, so many arguments! What’s reasonable is very grey and very arguable…play ball!

John Hyre

Re: Please explain advantage of S-corp - Posted by JT-IN

Posted by JT-IN on January 18, 2002 at 11:17:36:

Dave:

Only to the extent of the maximum cutoff of FICA earnings, which is $ 80,400 in 2001 and 84,900 in 2002; which is 12.4% SE Tax. However, the 2.9% Medicare Tax, continues to infinity.

So if you are earning in excess of the above limits, on your day-job, then the benies of an S-Corp are minimized, but still relevant on the 2.9% of Medicare Tax. Also, if in this situation, then possibly a C-Corp could hold more advantages, based on when Corp pays out or whether the Corp would continue to reinvest. A deeper topic… and I would suggest discussing this matter with JHyre; the real expert!

JT-IN

Not hardly… John - Posted by JT-IN

Posted by JT-IN on January 18, 2002 at 10:43:16:

JHyre:

I have expended the limits of my knowledge, in the previous post… I do not possess the skills to take it from A to Z, as the really smart guys, like You! I can just make it sound like I know what I am talking about…

So, I will have to keep buying those foreclosures, cause it is all that I know how to do. Thank goodness for that, or I would be out digging ditches, or worse… LOL

See ya soon. I’ll be resting up for that one!

JT-IN

LLC corp and LLC company - Posted by Bud Branstetter

Posted by Bud Branstetter on January 19, 2002 at 12:41:05:

You can treat Limited Liability Companies for IRS purposes as either a corporation or a partnership. With a corporation, unless it is a single member, you have many of the same issues on getting money out as with other corp. If you LLC is treated as a limited partnership entity then the income can flow passively to you without the tax issues of a corp. You have the full legal protection of charging orders etc.

Re: Okay - Posted by The Baze

Posted by The Baze on January 18, 2002 at 20:39:19:

Sean,

Why an LLC over an S-corp? Mainly cost. If you form an S-corp, you’ll have to have an 1120-S filed every year. People like me charge pretty good money to prepare those. With a single member LLC, you simply report your rental activity on Schedule E of your individual tax return. People like me can’t charge as much for a Schedule E as we do for an 1120-S.

Why not a C-corp for holding rentals? C-corps do not receive capital gains treatment for the sale of assets. Capital gains are taxed at the same rate as ordinary income. Capital losses can only be used to offset capital gains. Excess capital losses are carried forward until there are capital gains to offset, or for 5 years. So if you sell a rental house for a $50,000 gain (let’s ignore depreciation recapture for the moment) that profit will be taxed at capital gains rates. If Sean, Inc. sells a rental house for $50,000 gain, it’s taxed at the same rate as its other income.

Why a March 31 year end? On March 31, you can accrue a bonus to you the president (make it reasonable and pay it w/in 30 days) and deduct it on the corporate tax return. Hopefully, if you’ve played your cards right, the corporation will now have zero taxable income. You will, of course, just upped your taxable income for the year. But, when is the tax on that income due? Yup, next April. Make sure you’re w/in the safe harbor rules, sock the money away, and make some interest at Uncle Sam’s expense.

Hope this helps.

Tom Bazley, CPA