LLC for flipping and I'm an out of state resident

[Bryan N.]

So, I'm active duty military with rentals held under my name and an umbrella. I'm going to start flipping. I was going to start an LLC because I was told that it will limit my taxes to 15%. Currently I'm in the 25% tax bracket. I'm a CA resident, but due to my employment I don't pay state tax in CA or VA. I asked my CPA about flipping within the LLC and his response was this:

"The character of the transaction is retained, whether in an LLC or not. Thus, the LLC will likely not having any effect for tax purposes."

I asked a second CPA and he said:

"Your CPA gave you correct but incomplete advice. The LLC itself is a generic entity. If you did nothing it would be treated as a "disregarded entity" or ignored for tax purposes. If you elected to treat the LLC as a corporation, you could take advantage of the 15% corporate tax rate but this involves planning as the money would be taxed again when you take it out."

There is a lot of confusing info on the internet about how taxes are handled.  Can anyone break this down to the third grade level for me?

Thank you 

[Brandon Hall]

@Bryan N.

Your first CPA is correct but doesn't understand real estate, especially flipping. 

Your second CPA also doesn't understand real estate businesses. Real estate should rarely be held in a C-Corp (or LLC taxed as a C-Corp) which is what he is suggesting. The list is endless for why you shouldn't hold property in a C-corp, and CPAs suggesting domestic owners flip or hold in a C-corp should be brought up on negligence unless there is some compelling reason for that advice.

Generally, flippers should be flipping in an S-corp. Not flipping in an S-corp will subject all earned profits to self-employment tax (15.3%) which is why your first CPA's advice is no good. In an S-corp, you pay yourself a reasonable salary which is subject to the self-employment taxes - the remaining profit is considered a distribution and not subject to self-employment taxes. 

You earn $100k on a flip. Taking the first CPA's advice, you will pay $15,300 in self-employment taxes alone. 

Taking a real estate savvy CPA's advice, you form an LLC and elect sub chapter S status. You determine a reasonable salary for your skills and level of effort is $50k. Of the $100k profit, $50k is salary and $50k is a distribution. As such, only the salary portion is subject to self-employment taxes and you pay $7,650. So your real estate savvy CPA has saved you $7,650.

Additionally, I have a few clients based out of CA and their entities are subject to the CA franchise tax, a minimum of $800 per year whether your entity reported a profit or not. So keep that in mind as well.

In summary, seek out a real estate savvy CPA.