AboutRichard Fritzler Expertise I am in the business of tax planning for business owners. Our company helps business owners structure so that they can be reduce the taxes that they owe, making them far more profitable.
Experience Since 1986 I have been helping successful business owners reduce taxes, protect assets, and limit their liability. The company is Owelesstax, incorporated at www.owelesstax.com
Organizations National Small Business Owners Association.
Nevada Association of Listed Resident Agents.
Citizens Legal Association
The Business Owners Institute
Publications Contributing author to "The Corporate Standard Newsletter".
I am also a writer for an email newsletter about business
Googlegroups/Successfulbusiness
I am also an Expert in the areas of Tax Law, Retirement Planning, and Estate tax issues.
Expert: Richard Fritzler Date: 11/3/2007 Subject: Small Real Estate Investment, Requires C-corp?
Question My husband and I are thinking to start a real estate investment business. We are looking to start small, buy one rental property to generate cash flow and then grow to own several rental properties. We are in CT and based on our combined income we are already at the one of the highest tax bracket. We are wondering if creating an LLC or C-Corp is better in order to protect our cash flow from getting added to our existing income and then having to pay out even more taxes.
Expected cash flow the first year = $500/month and goal is to grow this to $10K per month. Our accountant suggested we do nothing at all and just get additional insurance to for liability protection. Then when our cash flow grows to be significant, at that point create an LLC. However I don’t want to loose out on tax benefits.
I have done a ton of research and found some information about double taxation. However I agree with one of your responses that stated: “double taxation only applies if you pay dividends. So don’t pay dividends”. However I wanted to get your thoughts on something I read which said “No capital gains tax rate available to C-Corporations.” The article went on to say; “The preferential 15% capital gains tax rate available to individuals is not available to C-Corporations. Any gain on the sale of real estate by a C-Corporation will be taxed at the corporation’s regular tax rate, which can be as high as 35%.”
So the bottom line is that every time I read more about the topic I get confused as to which option is better. The goal is to invest in Real Estate and other investments…such as stocks, etc. The second goal is to keep the money that I have rightly earned by selecting the best entity, which will provide the best tax savings.
I know from your previous posts that you usually recommend Inc vs. LLC. For my particular case, what are your thoughts?
Thank you,
Alex
Answer I am also amazed at how confusing the accounting dogma tries to make it. At first glance it would appear, the accountants are smart enough to realize that making it seem confusing is the only way to keep their income sources. But the really amazing part is that they all believe the "smoke and mirrors" and ignore the facts, and in their ignorance they can continue the fiction. Your questions are a prime example of this fear mongering.
Let's dissect your quote:
“No capital gains tax rate available to C-Corporations.” The article went on to say; “The preferential 15% capital gains tax rate available to individuals is not available to C-Corporations. Any gain on the sale of real estate by a C-Corporation will be taxed at the corporation’s regular tax rate, which can be as high as 35%.”
The author can claim he did not lie, and made only factual statements. that does not mean he was telling the truth. What is not available to the corporation when it comes to tax rate on gains is the word "preferential"; the 15% is not only available but common and required.
The tax rate for corporations could be as high as 35%; IF, and only IF, the corporation receive more than $18,333,333 (that's right, 18 Million) of net profit in one year.
Here are the facts:
Capital gains for a corporation (long and short term) are taxed at the same rate as most other income (excluding dividends). So in our example we are going to compare an "extraordinarily" beneficial tax status for the individual with the mundane and common tax treatment of the corporation. (extraordinary because it was only recently that the Cap Gain Tax rate was lowered to the current rates, and is a point of argument in congress and the presidential campaign trail)
The Reality:
Corporations pay 15% tax on up to $50,000 of net profit regardless whether they are from gains, long term or short term or regular income, passive or earned. So the 15% is is certainly alive and well for the corporation it is just not preferential to gains. And for those that want to argue that the tax rate goes up for corporations as total income increases that is true, but there are offsets available to the corporation and increases in rates for the individual too.
The Application of reality: Before the corporation pays any tax it gets to spend that income on tax deductible reasonable business expenses. If the gain is $50,000 or less, in the year and there is no money spent on deductible items it is a tie when it comes to Federal Tax Rates. If you want to spend the money before taxes, the corporation wins hands down every time. Let's say there is a reasonable $75,000 of long term gains experienced on a rental property. For you the tax is pretty easy to calculate 15% federal and 3-5% state for a total of $11,250-$15,000. Leaving $60,000- 63,750 to spend.
For the corporation: let's first consider that it would be reasonable to pay for employee benefits such as healthcare, maybe only $10,000 for the year (but no tax on that), travel another $10,000 (no tax), Insurance (life, auto, home) another $5000, education, dependent care, and on and on. all of these expenditures are tax deductible for a corporation so you get to spend every nickel of it with no tax. Let me throw in the 179 deduction which allows you to spend up to $112,000 on anything that depreciates in less than 20 years, and I think I just spend the whole $75,000. A savings of $11,250, but even if we take that out and pay some taxes. We'll only spend $25,000 of the $75,000. If the corporation is in Nevada, (and it can be) we have no state tax, so the entire tax paid is $7500. That is $3750 less than you are paying. And the accounting mythologists say that is bad.
Is the Cap Gain Tax Cut instituted by Bush going to survive the next election? I don't know either. If it isn't better than the corporate rate now, why be involved with it when it could get much worse later.
So we have contrasted an example based upon a fully optimized situation in favor of the individual utilizing all of the tax strategizing for the 1040 tax return. Ignoring the "High Income Taxpayer" exceptions such as "phase out of deductions" and the AMT, and then compared it to a corporation that is "stuck" with that same example and how the taxes play out, and the corporation is the winner.
Change the gain from long term to short term and the corporation is miles ahead, consider the rents that you will receive as regular income compared to a properly structured corporation and the individual can't even run in the race.
Thanks for the opportunity to debunk a myth. I look forward to your call.
Richard Fritzler
www.owelesstax.com
phone 800 590-6612
