| Excuse me for sounding stereotypical, but it seems that it is the nature of most clever foreclosure investors to be “tight with their wad.” What I mean is that they watch every penny to make sure that any investment made is going to have a positive impact on the bottom line. The typical scenario is the investor who drives 15 miles out of their way to save $20.00 on materials. After adding up the gas and time wasted it really doesn’t make sense…and could very well amount to “stepping over dollars for dimes.”
Something else that doesn’t really make much sense is how little time is invested in a plan for lowering your largest lifetime expense, year in and out…your TAXES.
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The amusing part is if you knew you would make thousands more each year with a couple of hours of work on a small project each month…you all nod your heads yes and you know very well you would do it.
Sure, you might have talked to a tax advisor or an accountant about what to do to lower taxes, but chances are your accountant only calls you once a year to begin with, and even then he or she gave you the standard reply of either “operate in your personal name until you get bigger”, or to “run the business through an LLC if you are really going to work at it.” Keep in mind your accountant may not have thought you had hope of succeeding and just gave you the response that could have cost you thousands of dollars..(on top of forming the actual entity I might add).
Why is that advice going to cost you thousands of dollars? Let me spell it out to you: Poor Tax Planning and overpaid Self employment taxes.
If you are running a business by investing in foreclosure properties or if you are operating as a sole proprietor or a limited liability company, every dime that your business makes is going to be subject to self employment taxes!
Self employment taxes are an additional set of taxes (15.3% on the first $97,500 profit, 2.9% on any profits over $97,500) that you have to pay over and above your regular income taxes. In particular they are the taxes that knock everyone off their chair when they see that they were able to lower your taxable income to $20,000, but you still owed $10,000 in taxes.
Example 1: Joe’s LLC has a real estate business that generated $50,000 in profit for the year. Self employment taxes alone will create a tax liability of 15.3% X $50,000 = $7,650. Joe has a number of itemized deductions on his tax return, including a very large interest only mortgage. Due to the itemized deductions, he is able to lower his taxable income to $20,000. Joe will owe income taxes of about $3,000, but still owes the employment taxes of $7,650! Total taxes amount to more than $10,000, or over 50% of his profits.
Ouch. A simple solution that Joe can make is to run his business through a limited partnership instead of his own name or an LLC.
A very simplified explanation of a limited partnership is an entity that has two different types of partners, general partners and limited partners. The general partner of the limited partnership is in full control of the limited partnership, but also has full liability for the operations of the partnership. The limited partners have no control over the partnership and have limited liability for its actions.
Since the limited partners have no control over the partnership, the tax code treats distributions from the partnership to the limited partners as being “unearned” income. No employment taxes are due on unearned income. So that means that we are wiping out probably the largest part of your tax bill. Lets take a second look at the tax situation Joe would have faced, this time with Joe operating from a limited partnership.
Example 2: Joe’s LP has a real estate business that generated $50,000 in profit for the year. $40,000 of that is distributed to Joe as a limited partner and thus is not subject to employment taxes. Joe now only owes $1,530 in employment taxes. WE JUST SAVED JOE OVER $6,000 IN TAXES!!!! Joe will still owe income taxes of about $3,000, but his total tax bill now is only $4,530 as opposed to over 10K.
Something else we didn’t touch upon was the asset protection side of operating through a limited partnership. We’ll save that for the upcoming articles. In fact, stay tuned, we are going to be sharing with you a number great, gee whiz ideas, that are going to add quite a bit to your bottom line over the next few months.
See you in the next edition of The Tax Strategist for Foreclosure Investors and until next month…please don’t get any more free advice without something in writing that resembles a written tax plan to follow.
Tim Berry, Esquire
PS…If you would like to have a 30 minute discussion about how a plan to lower your taxable income could impact your actions and provide more clarity to your Investing ….please call 1-888-719-7674 or go to www.taxstrategybasics.com and sign up for a FREE one-on-one consultation with a business advisor who knows what odds you face every day and how to stack them in your favor. |
