How To Reduce your Taxes for Business and Real Estate Owners
We recently sat down with a client to create a tax strategy that involved different types of income such as a profitable business and real estate. Part of the exercise involved minimizing the tax liability by looking for a state in the U.S. with the lowest tax rate as well as securing the assets to avoid seizures from frivolous claims.
Business Income. A company producing net income close to a million dollars structured as a single member LLC. We recommend to implement:
- S Corporation election treatment.
- Increase Owner’s salary to reach a reasonable level.
- Defined Benefit Plan.
By filing S Corp election for the active business LLC, tax savings are 15% of the taxable income because of the elimination of self-employment tax that a single member LLC naturally creates. This election must be coupled with an increase of the salary the owner’s take to a level reasonable with his position.
A defined benefit plan will allow the company owner to differ up to $215K of income, but the plan must be extended to all employees. Many times business owners don’t consider this plan for the cost to fund the rest of the employees on the payroll, but the tax savings compared to a minimum employee matching make this an attractive strategy.
Personal Income. Sole member LLC status imposes an additional tax on this taxpayer’s income: self-employment tax 15%. Placing an active business within a solo member LLC creates this costly challenge. Our recommendation: to apply for S Corp status saved this client close to $100K in taxes.
Minimizing Taxes. In addition to the tax savings from self-employment tax, there was still room to reduce taxes by choosing a state with a lower tax rate. Puerto Rico offers a very attractive tax break structure, BUT you have to physically and really move to Puerto Rico with your family and live there for at least 183 days a year:
- 0% tax on interest and dividends.
- 0% tax on capital gains after becoming Puerto Rico resident.
- 4% tax on income.
- 5% tax on capital gains for assets purchased before you become a Puerto Rico Resident and sold during the first 10 years after moving to Puerto Rico.
Following the same strategy of tax minimization we recommend the following to reduce even further your tax bill:
- Create a Corporation in Puerto Rico
- File for S Corp election
- Puerto Rico S Corp becomes the owner of each LLC in other states
This will make the LLCs pass thru profits to the Puerto Rico S Corp that in turn will flow the personal income tax return to pay a 4% tax only.
Asset Protection. When there are several real estate properties owned in different estates in the U.S. as well as internationally. Some of the rental properties were owned personally and others thru LLCs. Owning real estate personally will subject the owner to a large risk in case that one of your tenants suffers an accident and sues you. Even if the property is owned thru an LLC and you there is a single member, there is a risk that the court considers the LLC a disregarded entity and the owner be responsible personally. To mitigate this risk, separated LLCs should own each property and the Puerto Rico S Corporation should own each LLC. The Puerto Rico S Corp will also work as a real estate management company.
In addition to the rental real estate protection, two other options are available, a land trust and a living trust. The real estate rentals could also be placed on a separate land trust and make each LLC the beneficiary if the properties are leveraged and the owner is worried about the due-on-sale clause.
The living trust is good for personal and real estate property to add a level of asset protection and for asset distribution to the next generation.
Fulton Abraham Sanchez, the founder of FAS CPA & Consultants of Miami, FL, is a Certified Public Accountant specialized in Tax Planning. You can email him to firstname.lastname@example.org.
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