Q: When starting a Real Estate business involving flipping houses will an LLC do, or should we look into an S Corp? Thanks
We are looking for the best asset protection vehicle for this venture. Thank you.
A: First off, the big difference between LLC's and S Corps are the way that they are taxed and the formalities that have to be observed. They both offer the same liability protection. Some attorneys may argue that LLC's are relatively new and because they are relatively new, the body of law surrounding them haven't been tested. In my experience, I haven't seen many issues (if any) that have turned on the fact that the business entity was an LLC rather than a corporation. Embezzling in an S-Corp will give you the same in an LLC along with a myriad of a dozen other civil claims. If you hire an attorney to set these up for you, you will probably pay 50% more to set up an S Corp than an LLC.
That being said, LLC's are state creation and are taxed the same as a partnership. However, you can as an LLC elect to be taxed like an "S" corp which makes the taxation distinction disappear and leaves only the formalities. In a corporation in order to maintain the "corporate veil," you need to have regular meetings, keep notes, and cast votes on company decisions, with company documents setting out the specific functions of the board of directors and the shareholders. An LLC is much simpler. It does not require regular meetings and depending on the ownership doesn't need any meeting at all.
The question isn't really whether an S Corp or an LLC is better suited for a company that does housing flips, as they both offer the same liability protection, the question really should be, " how should the business entity be taxed?" which depends on how much money profit will the owners of the company be making as well as how much will the owners be "working" the business.
The elements you will want to consider is whether you want to save more money in taxes and get less social security income later (in life), or whether you want to fully contribute to the "self-employment" tax thus getting more social security later.
In a single member LLC, you can simplify your taxes. You fill out a schedule C (profit and loss statement) for your business and attach it to your normal 1040. The IRS deems your business a disregarded entity and acts like it doesn't exist. The amount of profit earned by your business is attributed to you as income and you are taxed on it.
If you elect to be taxed as an "S Corp" you basically hire yourself as a W2 employee and pay yourself a "reasonable salary" and whatever money you else you take from the company is an owner's draw. In order to do this, you have to be engaged in the day to day operations of the business, you can't be a passive investor. In this way, you count the "reasonable salary" as a business expense for your business, but you report it on your 1040 as W2 income. You are thus only paying the self-employment tax on the "reasonable salary" portion vs all of the profits in if you were to just fill out a schedule C. Your "owner's draw" income would be taxed as ordinary income, but would not be subject to the self-employment tax. Thus you get more of your money now, because you contribute less to the self-employment coffer (medicare, social security, etc), but on the flip side when you are 62 or whenever you decide to take out Social Security (providing it is still there and you make less than $500k/year) then you will get less in social security because you didn't pay as much into the fund.
So in summary, you will want to consider 1) will you be engaged in daily operations, 2) What tax bracket are you in now 3) how many owners are there 4) whether you think you can invest/save the money you aren't paying in self-employment tax better than the government social security program. 5) how much administration you want to deal with as well as starting costs.
I hope this helps, a little long-winded, but I never know how much background to go into because I never know what your knowledge base is coming into the question.
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