Pass Income to Another Business to Buy Investments. Tax Evasion?

Question

A friend and I are both starting our own painting contracting companies, and something we were both thinking about doing with our profits, if we are good enough to make high profits, is invest in real estate. But we're trying to find a way to do it with pre-tax money. We both have LLC's electing to be taxed as S Corps as our business structure, to avoid some payroll taxes.

My initial thought was to create another entity, pass ownership of the painting business to that, and use that for buying investments, and then anything remaining gets passed through to me as distributions(we both collect a reasonable salary from the painting businesses).

So it would look something like:

Painting Company makes $250k profit. As an S corp, it's passed through to Investment Company, it's owner. Investment Company makes a $150k investment, and pass the remaining $100k to me as distributions, which are then taxed as income.

Would that be considered tax evasion?

As an alternative, are there other ways for us to invest in real estate, without paying taxes on the money we use to invest? I'm looking into self directed IRA's, but my initial gut feeling is that, being a retirement account, we won't be able to use the profits from those investments as we please.

Thanks!

Dave Toelkes · Answer

The S-corp made $250K. The S-corp issues a K-1 to its owner showing a taxable profit of $250K. The owner then pays income taxes on $250K of income at the owner's applicable marginal tax bracket rate. If the owner purchases real estate with some of the $250K, it is purchased with after tax dollars.

Does not matter in your example whether the S-corp owner is yourself personally or another pass-through business entity.

Shawn Torsitano · Answer

Thanks, I appreciate the input, I was hoping it could be considered an expense, but am now getting that's not how it works.

Just so you know though, salaries are going to be paid before distributions, and the investments are going to be in a separate legal entity no matter how I invest.

Chris Soignier · Answer

Your scheme is full of holes.   First, investing itself is not an expense.   You or your company can buy properties, but legitimate deductions are things like depreciation, maint., property taxes, etc.

Secondly, you need to pay salaries before S-Corp. distributions unless you want to do some explaining, and likely penalty paying, to the IRS.

Thirdly, it's not a great idea to mix ownership of real estate w/ another business in the same legal entity.

As far as I can tell, the best way to generate and use tax-free money for real estate investment is to start a church.    ;)

Shawn Torsitano · Answer

Thanks for the info Linda. Does that also apply to an LLC electing S-corp status, and to LLC's in general? The S-corp election is to limit my payroll taxes, if there was another company in between, I would think I could eliminate the S-corp status of the paint business, since, as far as I understand it, the LLC still passes through income in a similar fashion.

Linda Weygant · Answer

Only real persons can own stock in an S-Corporation.  Another entity owning the stock would invalidate the S-Corp and the IRS would revoke the status and change it to a C-Corp.

Shawn Torsitano · Answer

Okay. Thanks for the clear answer, I appreciate your time.

Shawn Torsitano · Answer

I'm looking up CAPEX stuff, and I think I'm starting to get it. I'm still new to the accounting side, and have never really operated as a broker, despite holding the license. So what it looks like, then, is that I could deduct the portion of the property the year I buy it, for that year of depreciation, but overall the amount of the down payment not counted in that would still be taxed as income?

Shawn Torsitano · Answer

Thanks for the reply, but I'm not 100% sure what you mean by your response.Of course, I'll talk to a CPA before I actually do anything, but I was saying more that if there is a business that is in the business of real estate investing, which would be the shell corp, would the purchasing of real estate investments be essentially considered a legal business expense? I get that it would be an assest, and the depreciation would be over a period of time, but I'm trying to figure out if the money spent on that would still count towards taxable income.

Wayne Brooks · Answer

Not hardly, talk to a CPA.  If that idea worked, you wouldn't need the other shell co.  As a broker, you should know that "buying" $150k of real estate, doesn't give you a $150k deduction.

Pass Income to Another Business to Buy Investments. Tax Evasion?

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