Tax Saving Entity Structures

I find that most people have a good grasp of the basics when it comes to entities, but are often missing the little things that can have a huge impact (good and bad) on tax savings. I have a real-life story that captures this well.

Pierre is starting a business and calls his tax preparer to ask what type of entity he needs for his business. Pierre’s tax preparer responds with what Pierre refers to as “confusing accountant talk,” but Pierre is able to translate enough to learn that S Corporations are best for businesses. So Pierre forms his S Corporation and is off and running his new business.

At the beginning of the next year, it’s time for Pierre to do his tax returns. Pierre’s new business had losses its first year, which Pierre expected. While Pierre is not excited about the losses, he is excited that at least the losses will offset his wife’s salary so they will pay less in tax.

But Pierre is shocked and surprised when he receives his tax returns! First, he learns he can’t take his business losses currently because he didn’t fund the losses personally. Instead, his S Corporation funded the losses by getting a bank loan that Pierre guaranteed. Second, not only does Pierre have an unexpected tax liability, he also has higher tax return preparation fees because he now has 2 tax returns to file – his personal tax return and his S Corporation tax return.

Better Tax Results with a Sole Proprietorship than an S Corporation! Really? In this tax story, Pierre would have had better tax results if his business was taxed as a sole proprietorship. In a sole proprietorship, the losses would have been fully deductible and the business activity would have been included in Pierre’s individual tax return so there would have been only 1 tax return to file. Plus, this could have been done in such a way so Pierre could still have his business taxed as an S Corporation in the future.

Pierre was shocked to learn this! He had always heard that sole proprietorships were terrible and to avoid them by any means necessary!

STOP RIGHT HERE! The first time I shared this story, I received some emails from readers telling me I was crazy. Was I really suggesting a sole proprietorship over an S Corporation? The answer is yes and no. Yes, for tax savings purposes. No, for legal purposes. The good news is you can have it both ways because…

Tax Terms Do Not Have the Same Meaning as Legal Terms

Tax strategies and asset protection planning use the same terms but they have very different meanings.

Let me give you an example. You buy a rental property and put it in a Limited Liability Company (LLC). You are the only member of the LLC.

For legal purposes, your rental property is owned by an entity – your LLC. For tax purposes, your rental property is treated as if you owned it directly – meaning it is taxed as a sole proprietorship.

In this case, there is a sole proprietorship for tax purposes but not for legal purposes.

LLCs are extremely flexible in how they are treated for tax purposes, making it possible to have a sole proprietorship for tax purposes and an entity for legal purposes. Even better, LLCs can also be taxed as Corporations (C or S Corporations), so they are extremely effective when creating tax saving entity structures.

Why Didn’t Someone Tell Me This? Pierre learned all of this too late and of course asked his tax preparer, why didn’t I know this? And that’s the heart of this issue. Pierre did the right thing by asking his tax preparer about the entity early on, but it was an issue of – you don’t know what you don’t know.

In a perfect world, the tax preparer would have asked the right questions to learn more about Pierre’s goals and situation and would have translated “confusing accountant talk” into something clear and understandable. In general, S Corporations are good entities for businesses. But, they can be terrible when there are losses, and losses are common when a business first begins.

Expert Advice in a Cash Crunch

Tax advice is very specific to each person. When I first work with a new client, I spend at least 3 months with that client focusing on their goals in order to create a tax structure that works for them. And I coach them on the triggering events they need to be aware of that will change their tax structure so they learn when they need to ask questions.

Business owners and investors need expert advice when they are starting their business or investing and this is the same time when they feel the greatest cash pinch! It’s clear from the business owners and investors I talk to that they all want the expert advice, some believe (right or wrong) that they just aren’t in a position to pay for it at that moment. What they usually do is get a quick answer (like Pierre) and deal with it later. Unfortunately, the nightmare stories people share with me end with “deal with it later” meaning paying much more later.

Cost Effective Solution

Many people ask me if I have a “cost effective” solution. Translation: “I’m willing to spend a few hundred dollars, do some of the leg work myself and I want a lot of bang for my buck!”

I learned quickly that business owners not only want, but need, an inexpensive way to get up to speed on entities and tax structures so they can better prepare themselves to meet with their tax preparer.

Over the past year I have taken the key points, questions and scenarios I use to coach clients and created a “cost effective” solution – a 5 part teleseminar course designed to create awareness about the little things that have a huge impact on tax savings.

Behind Every Secret Remember, behind every one of my secrets is knowledge – the type of knowledge that makes you aware of what creates massive tax savings so you begin to see your daily routine a little differently…like the huge impact entities have on your tax savings!

Price Monitoring Structure Under GST in the Pipeline

According to the dictionary, meaning monitoring means to supervise activities in progress to ensure whether the objectives and the targets are met. Price-Monitoring means to observe and check the prices over the duration of time and to keep a systematic review of the pricing.

GST is a bill passed by the parliament to remove the various indirect taxes like VAT, and other taxes and to subsume it into a unified tax structure. This benefits the country in having a streamlined tax collection process that is less time-consuming and more efficient.

The business owners and working professionals now benefit from tax relief provided to them under GST based on different qualifying criteria.

In addition, working professionals and business owners must get their GST Registration done to get the GST number if they have not applied for the same.

A price monitoring structure has been proposed by the government under the GST regime to ensure various benefits of the reforms or changes in any unjustified price disturbance.

With the effects of the bill, it tends to provide a push or boost to the economy. The GST is expected to put in place latest by April 1st, 2017, where taxes on goods are expected to fall sharply after its effect.

The GST regime is undoubtedly the biggest tax reform post-independence. The main aim of the bill is to remove or eradicate all the unnecessary or indirect taxes into a unified tax structure, which would result in a sharp decline in logistics and taxes as well.

Keeping in consideration the federal structure of the country must work flawlessly. The centre and the state will collect the GST. The tax collected by the centre is called CGST and taxes collected by the state are called SGST.

There are some similarities and differences between the CGST and SGST’s in individual states. The CGST and SGST are applied on products, goods, and services on the destination principle. Thus, making the exports will become zero-rated and the imports will attract tax in the same manner.

As far as the interstate trade of goods and services is concerned this will attract an Integrated GST. A price monitoring structure without sufficient legislative backup may from the legislature be ineffective and an additional compliance shall necessarily be imposed.

The government does not want any increase in price or inflation after the implementation of the GST, so it does not ensure its effectiveness without the proper backing of the legislature. This could lead to intricate paper works and it shall ensure that the GST rate is feasible enough thus making a smooth credit system.

It is evident that after the implementation of the GST, regimes in many countries have actually added up inflation and by the price, monitoring structure the government expects to avoid a similar situation by lowering the tax rate.

By the price monitoring mechanism, the government tends to abstain frequent dabbling of rates to make a steep specific sector.

It would be more suitable if the GST rates were lowered in the beginning.

This would definitely make sense due to the variation in VAT across the country. It has also been said that the center will compensate for any revenue loss for five years post GST implementation.

The price monitoring includes the standardization of rates along with levying on goods. The GDP of 2%increase is expected and any other benefits are expected. The price monitoring structure of the government tends to remove the doubts on whether it would result in negative impacts or not.

The structure ensures that there is no downside of the bill and with proper implementation and the backing of the central government. It is expected to bring a positive impact of the implementation of the bill.

A price mechanism is necessary and many are of the opinion that it is better to have multiple rates as a large part of the economy.

This is similar to the EU where VAT rates change across the states, keeping a SOP to the minimum tax base would lower the rate of GST.

A wider tax base gives a wider scope to lower the rate of GST that allows credit for input taxes that are paid across the value chain, which would result in efficiency, and overcast the retail prices as well.

Mid-Year Tax Planning – Do You Need to Add an Entity?

Do you need to add an entity to your tax structure?

This is such an important question for mid-year planning because knowing the right time to add an entity to your tax strategy can often save as much as $10,000 per year in taxes!

What entity should you consider adding to your tax structure?

Many of you want to know what entity you should consider adding to your tax structure. There are 2 levels of tax planning to consider in answering this question.

** Level #1 **

This level is for those business owners or investors who are either just starting their business or investment or are in the “ramp-up” phase of their business or investment. The ramp-up phase may mean you are a few months in to your new business or investment, or perhaps even a few years depending on the type of business or investment. The ramp-up phase means your business or investment has not yet produced a profit. Now, without profit, taxes are likely minimal or even non-existent, which is why the focus of this level is building a strong foundation for your tax structure so once there is profit, your tax structure is already in place to immediately minimize your taxes.

I often get asked the question “When should I form my entity for my business (or investment)?”

Many of the people I talk to are unsure if they should get their business up and going first, and then worry about the entity, or if they should have the entity in place even before starting the business or investment.

The answer to this depends somewhat on the type of business or investment, however, if I have to give an answer, I recommend setting up the entity first. This is because the right entity can grow and change with you as your business or investment grows and changes. Plus, outside of the tax benefits, many entities offer some level of asset protection which most people rank as an important planning factor.

So for those of you in Level #1, the entities to consider adding to your tax structure are:

Limited Liability Company (LLC). LLCs are the most flexible entity for tax purposes. LLCs can start off being taxed one way and then elect to be taxed differently. This means your LLC can adjust to the tax planning needs of your business or investment because your LLC can be taxed as a sole proprietorship, partnership, S corporation or C corporation. This flexibility is key in building a strong foundation for your tax structure and to minimize future taxes. S Corporation or Partnership. If your LLC will be formed in a state that assesses a separate tax on LLCs, then you should consider adding an S corporation or partnership instead of an LLC.

** Level #2 **

Level #2 is for those who already have a strong foundation in place for their tax strategy, and whose business or investment will soon be exiting the ramp-up phase or has already exited the ramp-up phase and is producing income. At Level #2, the focus is minimizing the tax liability created by your business or investment.

Consider a C Corporation if you are in the Level 2 planning group

One way to eliminate – not just reduce taxes – is to shift income to a taxpayer in a lower tax bracket. A C Corporation has initial tax brackets of 15% and 25%. If you are in an individual tax bracket of 25% or higher, then there could be an opportunity to reduce your taxes by shifting some of your income to a C Corporation.

For example, if you are in a 35% tax bracket individually and are able to shift $50,000 of income to a C Corporation, then your income tax is reduced by $10,000! And this can be an annual savings of $10,000!

BUT…

I know from experience that any time I suggest a C Corporation in a tax strategy, people panic! They think of all the bad things they’ve heard about C Corporations:

But what about the double tax?
But what about the personal service corporation tax?
But what about getting money out?
But what about the accumulated earnings tax?

What most people don’t know (including many CPAs) is how to legally avoid these tax traps…BUT I do! In fact, some of them are not even tax traps at all – I have found ways to use some of these so-called traps to save taxes!