[Doc]

If anyone on this forum is an accountant, would you please tell me if I have to pay additional tax for creating a Limited Liability Company? The guidelines say that I'd have to pay a "self-employment" tax, but the business is only part-time (seasonal).

I guess what I want to know is the advantages/disadvantages of forming an LLC (not a corporation). If anyone has experience in this area, please share.

 

[Jena]

i don't have any experience, but i read a very good article about LLC's created to protect folks from liability for on-farm chicken processing. i think it was in "Grit" the newsletter sent out by APPPA.org, but not sure.

the biggest thing I came away with was that you MUST maintain your LLC appropriately and set it up correctly. it might be on the apppa site.

jena

 

[Guest]

An LLC can be taxed either as a "pass-through" entity, like a partnership or sole proprietorship, or as a regular corporation. If an LLC chooses to be taxed as a pass-through entity (and most do), the owners of the LLC are not subject to double taxation. This is as opposed to a regular corporation, which pays a corporate tax on its net income (the first tax) and then a second tax when the corporation distributes profits, as the stockholders pay income tax on dividends. Partnerships and sole proprietorships do not have to be treated as taxpaying entities. The profits "pass through" to the owners, who pay taxes at their individual tax rates.

 

[fordy]

...................Any net income that is passed thru and reported on a partners form 1040 from Either a Partnership or Subchapter "S" corp. that EXceeds 400 in any given year is subject to Self employment (SS) tax. Income tax will be a completely separate matter.........fordy....

 

[Doc]

It isn't a partnership LLC, it is a company LLC. No partners. Just me. What I am reading is that self - employment tax is different from anything that is "passed through", which is income tax?? I'm sorry, but I'm confused.

 

[fordy]

................The net income...<or>...net loss is passed thru ...TOO you , usually on a K-1 form that has a list of sources of income and depending upon the Nature of the income as shown on the K-1 , will Dictate how the income or loss is treated when it is reported on your personal 1040 form. For instance if you owned several rent houses the net income is subject to income Tax but NOT subject to Self employment tax(ss). So, if your net income as reported on the K-1 is Strictly from your business, it will be subject to self employment Tax and income tax on the basic level. Just as your income would be taxed if You had received a W-2 form from your employer, the employer withheld Fica from your check and matched IT when he made his form 941 federal Payroll tax Deposit. And, you also had w\h for Income tax purposes based upon the Number of deductions claimed . Then at the end of the Year you filed your form 1040 and figured your Income tax due and subtract your total paid in and maybe you had a Refund coming. For self employment....you should have been making Estimated tax payments approximately every three months . Your estimated Tax will include BOTH income Tax as well as Fica on the ESTIMATED NET income from your LLC for the FULL 12 months. ............fordy...

 

[Doc]

Ok, now I'm getting clearer. But, I do have a question: if my business is owning rental property, why don't I have to pay self-employment tax? Sooo, what is the advantage of an LLC (LL company)?

................The net income...<or>...net loss is passed thru ...TOO you , usually on a K-1 form that has a list of sources of income and depending upon the Nature of the income as shown on the K-1 , will Dictate how the income or loss is treated when it is reported on your personal 1040 form. For instance if you owned several rent houses the net income is subject to income Tax but NOT subject to Self employment tax(ss). So, if your net income as reported on the K-1 is Strictly from your business, it will be subject to self employment Tax and income tax on the basic level. Just as your income would be taxed if You had received a W-2 form from your employer, the employer withheld Fica from your check and matched IT when he made his form 941 federal Payroll tax Deposit. And, you also had w\h for Income tax purposes based upon the Number of deductions claimed . Then at the end of the Year you filed your form 1040 and figured your Income tax due and subtract your total paid in and maybe you had a Refund coming. For self employment....you should have been making Estimated tax payments approximately every three months . Your estimated Tax will include BOTH income Tax as well as Fica on the ESTIMATED NET income from your LLC for the FULL 12 months. ............fordy...

 

[fordy]

................The IRS makes a very basic distinction between Passive (not subject to SS tax) and Working or Earned Net Income from a Small Business. This Discussion is NOT related too Any Facet of the Tax Treatment of a Regular Corporation .
................Residential Rental Property is a very Special case in Tax Law. Tax payers have always owned rental property and traditionally it wasn't subject to self employment tax. BUT, if the IRS makes a Determination that a taxpayer is "IN THE Business" of rental property, they can force the taxpayer too Pay SE tax. This change in status can be triggered by the Number of rental properties that the taxpayer owns. Also, another factor is does the taxpayer have a Regular job NOT related too rental property, i.e. Is his sole source of Income derived from the rental Property exclusively???
...............The Best facet of rental property is that you are Allowed to write off UP TO 25,000 in Net Losses each year and you can use these losses to OFFSET(reduce) net(earned) income from Your Small Business. Example...Lets say your Net from small bus. for '03 was 30,000. And your Net Loss from rental property was 25,000. (2) things will happen.....(1).You will only have 5,000 that will Possibly subject too INcome Tax not counting any other sources of taxable income you may have. (2) You STILL have to pay self employment tax on your Net from small bus. of 30,000. But your taxable income was directly REDUCED by the 25,000 in losses from your rental loss.
..............Note This . If you had a job that paid you say 60,000 ayear. That 60,000 would ALSO be offset by the 30,000 in rental Losses. Most tax payers are NOT aware of this situation unless a knowlegeable tax Preparer has explained it to them...........fordy.....

 

[Guest]

If you are the sole employee of the LLC or any other corporation, it would be fairly easy for a good lawyer to "pierce the corporate veil" and get at your assets.

 

[fordy]

...................Yes! 100% correct, and that's the Reason that Smart Folks spend about 2k dollars and Put all assets into a Trust . Then , those lawyers don't have much of a chance to subject a persons assets to a damage award from a Civil court judgement.............fordy....

 

[Guest]

It's probably more than 2K now, and they have to be set up just right. If they ask in court "are you the beneficiary of a trust" for example and you are, that can open the door for them to still get your money. That is another reason people/businesses have so much insurance. Sad, too, because so many lawsuits are frivolous.

Some assets (and this varies by state) can't be gone after in a civvil lawsuit. You can only garnish such and such a percentage of income, for example. So the trust would hopefully be to protect the other assets you have. And then if you're in a community property state you may want to keep each spouses assets separate so an innocent (and I'm not talking malfeasance here, just that they'll go after whatever they think they can) spouse doesn't suffer from a frivolous lawsuit as well.

 

[apirlawz]

If anyone on this forum is an accountant, would you please tell me if I have to pay additional tax for creating a Limited Liability Company? The guidelines say that I'd have to pay a "self-employment" tax, but the business is only part-time (seasonal).

I guess what I want to know is the advantages/disadvantages of forming an LLC (not a corporation). If anyone has experience in this area, please share.

Doc, my hubby is a tax accountant...he does this for a living!

Here's Brad-

In most cases it is correct that you'd have to pay self-employment (SE) tax on any earnings from a LLC. SE tax is the equivalent to an employee's social security tax. Unfortunately, with no employer to split the cost of the SE tax, as an LLC member, you get stuck paying the entire tax (15.3%) by yourself. Add that to the income tax (from 10% to 35% depending on the rest of your income), and the total percent you're paying in tax is between 25-50%!
This describes what happens when you register the LLC with the IRS to be taxed as a partnership. You could register the LLC to be taxed as a C corp, but the results wouldn't be much better. (A quick comment about the SE tax-even though it sounds oppressive, it's there to right a potential wrong. If you owned and worked at an LLC all your life and you did not pay any SE tax, then you would not be eligible for social security when you retire. You're paying a tax to make sure your not left out of that system. How long that system will exist, however is completely different, frustrating topic).


The above applies to an LLC taxed as a partnership regardless of how long you conduct business. What will be more important is your personal effort in the activity. For tax purposes the IRS has various tests to determine if the business is a "hobby" to you versus a true business. The simplest test is if you spend 500 hours or more in the LLC. If you do, that would allow you to deduct any LLC loss against your other income (profit of an LLC is taxed regardless of whether it qualifies as a hobby). There are 9-10 other tests that can be used in defining the business as a hobby, and the answer to the tests is determined each year. In most cases, you'd want to avoid the business being a hobby.

Some of the rest of the story on LLC's:
- must be registered with the Secretary of State
- may an unlimited number of members or just one (be aware of legal and tax aspects of "single-member" LLCs)
- some states do not permit some businesses (for example banks) to be an LLC
- liability protection to individual members
- can have a perpetual or limited life (a regular partnership "dissolves" when a partner dies)
- ownership interests in an LLC can be sold
- almost any other kind of entity may be a member of an LLC

There's more, but those are the highlights. The basic benefit of an LLC is the limited liability, and if you're product or service does not put yourself or anyone at a substantial risk, then the exercise of setting up an LLC is not worth it, unless you feel you have substantial assets to protect. If you are still interested, contact your Secretary of State's office and ask about forming an LLC. If you decide then that it is the correct form for your business, I would suggest contacting an attourney to help get it set up to your specifications.


April here...Hoped that helped! I'll be doing the same thing here in a month or so. Boy, am I glad I married an accountant!!

 

[Doc]

You two have raised more questions and I appreciate your feedback. Especially since I have actually talked with an attorney who did not mention setting up a trust, or anything else for that matter to protect personal assets.

My situation is this: I own a small farm (in North Carolina) and plan to rent three acres to the public for special events/parties -- whatever. It is pasture space. I was encouraged to set up a LLC (company) since I am the sole member/manager -- "to protect my personal assets". It is a seasonal kind of rental and VERY part time (weather-dependent since it is outdoors only) -- I cannot imagine that this rental would clear more than 10K/yr. In addition, I also own one rental unit (garage apartment) that I had planned to include in the LLC.

Now, however, after reading your comments, I am questioning whether or not the LLC is the right avenue. I thought that I needed an accountant's answers, but perhaps I need to see a different attorney. I keep reading that it is very important that the LLC be set up "properly", but the Articles of Organization from the Sec of State are very, very simple (and in conversation with them, they stress that I do NOT need an attorney). I get the sense I'm missing something.

I'd appreciate advice...

It's probably more than 2K now, and they have to be set up just right. If they ask in court "are you the beneficiary of a trust" for example and you are, that can open the door for them to still get your money. That is another reason people/businesses have so much insurance. Sad, too, because so many lawsuits are frivolous.

Some assets (and this varies by state) can't be gone after in a civvil lawsuit. You can only garnish such and such a percentage of income, for example. So the trust would hopefully be to protect the other assets you have. And then if you're in a community property state you may want to keep each spouses assets separate so an innocent (and I'm not talking malfeasance here, just that they'll go after whatever they think they can) spouse doesn't suffer from a frivolous lawsuit as well.

 

[fin29]

All you do is create an operating agreement that you keep on file at home (you can find templates on line), file your Articles with the Secretary of State, get a separate checking account for the business, and keep all your receipts separate and work very hard to not comingle your personal and business accounts. Get a liability policy for the amount of the judgement cap in your state, and start your business.

 

[fordy]

.................The biggest issue here from what I see is Your Potential Liability for any Injuries either claimed or real that results from Civil law suits. The whole idea of a LIMITED LIABILITY business is too Protect you and your assets ....and to Limit your liability. So , if an attorney files a suit against the LLC they can ONLY collect from the assets contained in the LLC. The actual land and all other tangible assets are All Stored and shielded behind the Legal wall of A trust that was Structured Specifically for that purpose. The other item that needs attention is that you need to secure a general Liability policy to the Tune of 5 million so that it will take the HIT , IF a lawsuit was able to penetrate the Trust and therefore subject your personal assets to seizure. ....fordy....

 

[Mike in Ohio]

Doc,

You need to consider the liabilities you are trying to protect against. It may be that a single LLC will serve your needs or it may be that you actually want to set up 2 or more. The law in your state also has a big impact.

For example, you may want the land under one LLC with the rental business (renting the land from the first) being a second LLC.

You can also have an LLC owning another LLC. For example, let's say your LLC is in a state that doesn't have strong protection. That LLC might be owned by an LLC in Nevada which has stronger protections.

I forget the legal term but Nevada generally won't allow a judgement to go after the assets of an LLC but will allow collection from any distributions. This can cause some weird consequences for someone that wins a judgement in that they may be liable for federal taxes on money they can't actually collect.

I've done some research in this area but haven't actually pulled the trigger to set something up.

Mike

 

[fin29]

Just set up a rental or lease agreement (written on a cocktail napkin would be sufficient) between himself (the landowner) and his own LLC. The only way a judgement could lead to the land being seized as an asset is if he sold the land to the LLC.

 

[Mike in Ohio]

Fin29 wrote:

Just set up a rental or lease agreement (written on a cocktail napkin would be sufficient) between himself (the landowner) and his own LLC. The only way a judgement could lead to the land being seized as an asset is if he sold the land to the LLC.

Actually Fin29, this defeats the purpose of having an LLC (in some respects). The land can still be attached for any personal liabilities he might have. There would also be the question of whether it was an arms length transaction if he was representing both sides of the transaction....particualrly if the agreement was a cocktail napkin. The bottom line is that if you are going to do it, do it right.

It all gets back to what risks the person is trying to address in setting up the structure.

As usual, just my 2 cents.

Mike

 

[Doc]

Mike says: it all gets back to what risks are being addressed:

The risks will be whatever a person could do to sue, knowing it is a pasture area that is being rented -- with posted signs for those areas off limits on the farm.

Now here is a wrinkle: if I am renting -- land or apartment, do I have to pay self-employment tax? How would I be different from someone who owns and rents houses, not land (as mentioned above in one of the replies)???

Fin29 wrote:
Just set up a rental or lease agreement (written on a cocktail napkin would be sufficient) between himself (the landowner) and his own LLC. The only way a judgement could lead to the land being seized as an asset is if he sold the land to the LLC.

Actually Fin29, this defeats the purpose of having an LLC (in some respects). The land can still be attached for any personal liabilities he might have. There would also be the question of whether it was an arms length transaction if he was representing both sides of the transaction....particualrly if the agreement was a cocktail napkin. The bottom line is that if you are going to do it, do it right.

It all gets back to what risks the person is trying to address in setting up the structure.

As usual, just my 2 cents.

Mike

 

[fin29]

Fin29 wrote:

Just set up a rental or lease agreement (written on a cocktail napkin would be sufficient) between himself (the landowner) and his own LLC. The only way a judgement could lead to the land being seized as an asset is if he sold the land to the LLC.

Actually Fin29, this defeats the purpose of having an LLC (in some respects). The land can still be attached for any personal liabilities he might have. There would also be the question of whether it was an arms length transaction if he was representing both sides of the transaction....particualrly if the agreement was a cocktail napkin. The bottom line is that if you are going to do it, do it right.

Mike

What you're not getting, Mike, is that the transaction is between the LLC as an entity and Doc as the landowner. He's not representing both sides of the transaction. The LLC is representing one side (he just happens to be the manager) and Doc the landowner is representing the other. One of the biggest mistakes people make when considering LLCs is that they're somehow personally liable. If someone sues you for something, they sue the LLC, not you as the manager. You as the manager just happen to be the one responsible for dealing with the lawsuit.

BTW, I'm not saying a cocktail napkin is the most formal way to go about it, but it would be considered a legal document, just as you can hand write a check on the back of a candy bar wrapper and it will be considered commercial paper by the courts.