Should I elect my LLC to be taxed as a corporation?

Question

HI Bigger pockets I'm a newbie here and just starting out. I'm currently try to form an LLC and am going through process now and should I elect to be taxed as an LLC or Corporation? All we will really be doing is the occasional foreclosure flip in order to reinvest and also buying rental properties and trying to increase cashflow as much as possible then refinance and reinvest and so on the basic BRRRR strategy type stuff. So in only income we will really be having is some cashflow from tenants and the occasional personal donations from our personal funds if needed. Please respond or feel free to send me a personal message on this subject.
Thank you for your time!

Meagan Barkley · Answer

I am a CPA as well.  I am not a lawyer and cannot give legal advice.

I would not hold flip and rental properties in the same legal entity for liability reasons. If something goes bad on a flip and you get sued, your rentals could be would be open to the lawsuit.

I am not sure where this idea that if you have an S-Corp you can pay yourself wages and everything else is dividends comes from. For BOTH, the income passes through on the K-1s from the S-Corp or partnership, and will be taxed at your ordinary rate on your personal income tax return. The difference comes in with the amount that is subject to self-employment tax. All ACTIVE income from a partnership is subject to SE tax (rental income is not active and is therefore not subject to SE tax). In an S-Corp, only the REASONABLE wage paid to yourself is subject to SE tax.

Example: Say you have $70k of taxable income from flipping after $30k in wages ($100k in income before you 'pay' yourself). In both situations a total of $100k will be taxed at your marginal rate on your personal tax return (no matter how much money you withdraw from the business). For the S-Corp, employment taxes will be paid on $30k (1/2 by you and 1/2 by the S-Corp). For the partnership, $100k will be subject to SE tax, paid 100% by you on your personal return. The savings is the $70k of income you can say that wasn't wages and therefore not subject to SE tax.

To determine the savings, a quick number to use is 15% of the amount that wouldn't be subject to SE tax. So in the example above, if you have $100k in taxable income from flipping and paid yourself $30k in wages, you would save over $10k in employment taxes. (This won't work when you pass the social security wage base - $118,500 in 2016.)

Also, keep in mind, rental income is not subject to SE tax.

I found a nifty calculator: https://www.lawinc.com/corporation/overview/tax-savings-calculator

Clear as mud!

Dave Toelkes · Answer

You got a few confusing answers  because you did not know how to ask the question.  All LLCs, for federal income tax purposes, are treated as a corporation, a partnership, or as a sole proprietorship.  The single member LLC can elect to be treated as a corporation or as a sole proprietorship.  If no election is made, then the default is sole proprietorship.  A multi-member LLC can elect to be treated as a partnership or as a corporation.  If so election is made, the default is partnership.

There is no federal income tax election for LLC.

If you are the only member of the LLC, then your choices are to be treated as either a corporation or a sole proprietorship.  If you choose corporation, the default is C-corp if you don't file an election to have your corporation treated as an S-corp.  If both you and your spouse are the only members of the LLC, then you are a partnership (there is an exception for spousal members as the only members of an LLC located in one of the nine community property states).

If your LLC has more than one member, then you are either a corporation or a partnership for federal income tax purposes. Both the S-corp and the partnership are pass-through entities.  This means that the S-corp and the partnership file an information tax return with the IRS, but any income tax to be paid is passed through to the individual LLC member's personal tax return.  Moreover, the LLC (S-corp) income is passed-through to your personal income tax return whether or not you take a cash distribution from the LLC. An LLC treated as a C-corp files a corporate tax return and pays taxes on its income at the applicable corporate tax rate.

If you are running a rental activity, all of your rental income is passive income.  No need to establish an S-corp and convert some of that income to active income subject to payroll taxes.  For your flip business, keep it separate from your rental business.  Form a second business entity for flipping and keep your books separate.  Do not intermingle funds.  You want to keep your flip activity separate from your rental activity to avoid tainting your rental operation and having a rental property sale tagged as a dealer transaction (a flip).  When you are just starting out, doing an occasional flip, all of your income will be self-employment income anyway, so don't worry about reasonable salary issues, yet.  When your LLC (treated as an S-corp) has a significant annual income, then get with your accountant and determine how much of that income should be your salary (subject to payroll taxes).

Tony Hoong · Answer

@Austin Willman I am a CPA and the classic accountant answer is it depends. The answer mostly hinges on if there is a large amount of flipping going or if its just rental income. A general rule of thumb would be if you are flipping it would be better off to file as an S corp. Rental income head towards the LLC route.

You are correct on file as an s corp and pay yourself a reasonable salary and if you want to pay out dividends you can or keep the money within the S corp.

Jenifer Levini · Answer

Youre welcome. I'm glad CPA's jumped in to answer the tax questions. Their expertise is invaluable!!

Thomas Breedlove · Answer

@Tony Hoong @Jenifer Levini @Meagan Barkley @Dave Toelkes Thank you very much for the information it was very helpful!

Tony Hoong · Answer

@Austin Willman you hit it right on the head

Jenifer Levini · Answer

Hi @Thomas Breedlove,

One of the greatest benefits of forming an LLC is the pass-through tax option. If you elect to be taxed as a corp, you are electing to pay taxes twice on the income. Why would you even consider that?

Jen the lawyer

Jeff B. · Answer

Many LLCs are classified as 'an ignored entity' or passthru, meaning the K1 goes directly to you & the members.

As I recall, if you allow it to be taxed as a Corp, then the entity will pay taxes and then when you get a distribution on the K1, you get taxed on that same money - - yes open & blatant double taxation.

As always, consult your CPA for a valid opinion

Should I elect my LLC to be taxed as a corporation?

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