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Updated over 5 years ago, 08/08/2019
Am I about to commit tax fraud...?
I have the opportunity to purchase the (commercial) building that I have a business in.
We currently pay $650/mo in rent.
Our business is set up as an LLC.
We could purchase the building for $92K which would have a lower mortgage payment than what we are currently paying in rent.
What I'd like to do is no longer take a paycheck (which has higher a tax rate) and just pay myself with rental income by raising the rent that the business would pay. Is that illegal?
Also, what is the difference in tax rate when you compare rental income to owner's draw payment (or self employment tax)?
Originally posted by @Logan Reinard:
I have the opportunity to purchase the (commercial) building that I have a business in.
We currently pay $650/mo in rent.
Our business is set up as an LLC.
We could purchase the building for $92K which would have a lower mortgage payment than what we are currently paying in rent.
What I'd like to do is no longer take a paycheck (which has higher a tax rate) and just pay myself with rental income by raising the rent that the business would pay. Is that illegal?
Also, what is the difference in tax rate when you compare rental income to owner's draw payment (or self employment tax)?
Assuming your LLC is taxed as an S or C-corp you cannot do that. It must be Fair market rent. You are only doing a disservice by not paying into Social Security and paying wages. You could also lose other deductions. If you stop paying there is a point at which you would no longer qualify for disability in the event something happens. Roughly 40% or more of people will be considered "disabled" at some point.
Please speak with a competent accountant as you are required to pay a reasonable salary.
@Steven Hamilton II Thanks for replying. The surrounding buildings pay around $1000-$2000 a month. My pay at the coffee shop is not a high salary, I would still take a pay check but I've heard that tax from a business is much higher than tax from a rental property.
I would definitely pay FMV for rent, but that can be a little subjective. It's best to consult with an independent 3rd party such as a commercial real estate broker, or do your own research for cost per sq/ft for similar space to yours. You need to be prepared to justify FMV if you get audited. As long as you can do that, you should be ok.
As far as taxes, you are correct that rental income is not subject to FICA tax which is a significant savings. I would still advise you to take a reasonable salary as well that is subject to SE tax. This can all be a little complex, definitely consult with your tax preparer prior to making any of these changes to get their input but you are thinking in the correct direction to minimize taxes, as long as it's structured properly and well documented.
@Logan Reinard I am not a CPA and I’m not an attorney. This is just strictly my own experiences and my own thoughts on the matter. I repeat, I don’t know the answer to your question! Haha, but I currently pay rent to myself, but I also collect a paycheck. I would imagine that as long as your rent paid is about the fair market value, that would be no problem. I could see it being an issue if you’re paying yourself $10,000 a month when normally the building would rent for $2,000 a month or something. But I think as long as you’re renting at a fair market value, that’s totally fine. If that number isn’t enough to make ends meet for you, then you’ll have to keep paying yourself a paycheck. If your business can afford to pay the building expenses, taxes, insurance, and then rent, it’s a good way to pay fewer taxes. Not sure if that helps or not, but those are my two cents.
@Jeremy White & @Tyler Hampton Thank you for the input. That's what i was thinking as well. I've heard that if you pay yourself less than your employees you will get fined if you are set up as an LLC. Not sure if that is true or not... but i've been paying myself less than my employees since the beginning
Originally posted by @Logan Reinard:
@Jeremy White & @Tyler Hampton Thank you for the input. That's what i was thinking as well. I've heard that if you pay yourself less than your employees you will get fined if you are set up as an LLC. Not sure if that is true or not... but i've been paying myself less than my employees since the beginning
Not true. If your business was losing money, you probably wouldn't be paying yourself anything and may even be investing additional funds to keep things going. Business owner gets paid last, at least in every business I've ever run.
Also, if an LLC with disregarded entity status, you don't actually pay yourself w-2 wages. You are just taxed on the profit of the business. Again, probably a good idea to hire an accountant to sit down with for a consult and discuss these things to be sure you are compliant and understand how to optimize your tax position without crossing uncle sam.
Good luck!
@Logan Reinard,
My main business is consulting (until I become a full-time REI). I have to pay myself a reasonable salary for what I do, which is taxed as normal employee income. If I don't do that, "the man" could come after me. I know someone who skipped this part, and it wasn't pretty.
Profits are then distributed as normal income without Social Security and such.
I also take other tax advantages wherever I can, which I’ve discussed with a good accountant who is great with business owners. Essentially, any time I can make something a LEGIT expense, I do it.
Your issue stems from a reasonable salary for managing the business. You also did not clarify what your entity is taxed as. That makes a huge difference. If the coffee shop is an S-corp you'll have a different answer than if it is a sole proprietorship.
@Jeremy White will do. Thank you again
@Steven Hamilton II it is a partnership
@Barry Pekin I pay myself so little now I think anything over $100 more would be a red flag haha
@Logan Reinard in which case if you are a GP then your entire GP share is subject to SE tax. I'm not sure if you were referring to you actually being paid by w-2; however, if you are. you should not be taking a W-2 wage from the entity itself. You definitely need a consultation with someone qualified. I can try to give you a referral if you'd like in OH. What is the largest city near you.
@Steven Hamilton II I’m located just north of Youngstown Ohio. Cleveland would be about an hour away.