Expert: Richard Fritzler - 9/20/2009

Question
My wife (home maker) and I (retired corporate executive & professional engineer) are both Canadians. We intend investing in Virginia out of our savings, in an IT Franchise ($80-100K) and a small manufacturing company (250-300K). We have conceived incorporating a holding company registered as LLC (electing IRS form 1120 for tax), to provide to the two operating companies management expertise and investment loan. The two operating companies will be fully owned by the two of us, registered as LLC and electing IRS form 1040 for tax. We plan to employ a professional to work with me at the holding company and to directly manage the two operating companies. The operating companies will pay the holding company interest on loan apart from a payment towards the services of the professional.
We envisage the revenue of holding company towards interest payment to be 25-40%, the balance being the salary.  Based on our understanding, "If the corporation is receiving more than 60% of its income from passive sources, such as rent, royalties, dividends and interest, and the 5 largest stockholders own 50% or more of the stock it would be deemed a Personal Holding Company,"
1) Will the holding company be able to avoid being designated by IRS as PHC and thus get to benefit the lower tax rate of 15% on the interest income which will be $30-40K (after expensing the revenue for the professional’s services) ?
2) Will my wife's investor status be accepted as a passive investor in her investments in the operating companies and consequently will her income from share of profits be exempt from self employment tax?
3) If you perceive our objectives (implied in (1) and (2) above) are flawed, kindly give us your thoughts how we could structure our entities to overcome the same.

Many thanks


Answer
You have a number of the facts correct. PHC, LLC can be taxed as a real corporation, taxes are drastically lower for real corporations, etc.

But. . .

if your intent is to pay someone a salary just to inflate the "earned" portion of the income stream; then, the costs of that will far outweight any conceivable tax savings on what is left.

If you are setting up an LLC to be taxed as a corporation then why not use a real corporation in the first place.

Control Group Regs may still be applied.

PHC is an "AND" Statement. You looked at one side of the AND Equation. . .

You are paying payroll taxes for your "employed professional" for 60-75% of the total revenue to offset payroll taxes on your wife's income of 25-40%.

You have done this with the Flawed Assumption that you need to put all the money in your pocket.

The ideal solution. . .

Has to be based on what your ultimatel goal is. You have not reduced taxes nearly as much as you could. You have not given yourself the greatest flexibility of money management. You have not addressed any of the real pressing estate issues.

If these are your goals then there is a better way.

If your goals do not evolve around these three issues, then it will probably be a "different" better way.

Richard Fritzler
www.NevadaCorporateServices.com
phone for you to call me 800 590-6612