The Optimal Corporate Set Up
In April 2016, I wrote Part One of this series. You can read this article on JD Supra. Part one focused on the hobby loss tax rules. Four years later I am writing part two. Did I forget that I had written part one? Perhaps! As we progress through unknown territory post-pandemic, millions of Americans find themselves wondering what’s next professionally and economically. Is there a new job or profession on the horizon?
I lamented in Part I that both of my parents (of blessed memory) were comfortably retired by my age after a thirty-year career with the federal government. Fortunately, I enjoy my work and will work as long as I can, otherwise my retirement date would be the earlier of my passing or age 95! The financial calamity created by the convergence of the new Cold War with China, and the economic effect of the Covid 19 has left historic levels of workers unemployed.
There is also a pretty decent chance that if downsizing happens after age 50, you may never get another job in Corporate America of a comparable scale. This dilemma has also carried over to federal, state, and municipal workers who have heretofore enjoyed great employment stability and oftentimes richer retirement and employee benefit programs than private industry. Even teachers have had to consider all of their options.
Oddly enough, while Americans sat at home during the pandemic, millions of Americans decided to become day traders chasing the record setting level of market performance. Many Americans find themselves relying on various “gigs” to keep the ship afloat. Americans, whether they like it or not have become accidental entrepreneurs. The sad reality is that everyone that works in Corporate American is two weeks away or sooner from receiving their Pink Slip. The time between jobs can seem to be infinite. You can either spend your time looking for a job, or plan for the unemployment contingency by creating your own business while you still have your job. The bestselling business writer Michael Masterson suggests to his readers that a person should have multiple sources of income. This philosophy should also apply to those that are self-employed. Your primary business today may be great today and obsolete tomorrow.
This article is the second in a series of articles focusing on the ideal deal corporate structure for your business. Even if you still work in Corporate America or already have a business, the recommendations in this article still apply to you and should be cause to reconsider your existing corporate structure.
The Optimal Corporate Set Up
Despite that over sixty percent of small businesses are structured as S Corporations, I have long thought that this was a planning mistake. Following tax reform, the regular corporation (C Corporation) and a top marginal tax bracket of 21 percent, the C Corporation has staged a great comeback. The ideal structure contemplates a combination of various entities.
The basic structure is a limited partnership with a corporate general partner. The business owner will form a new limited partnership (LP) and a new C corporation. The business owner owns 100 percent of the shares of the new C corporation. The C corporation will serve as the sole general partner own a 1-2 percent interest in the new limited partnership on Day 1. The business owner personally own will initially own a 98-99 percent in the new limited partnership. The business owner will create a new limited liability (LLC) company for each separate business or real estate activity. Existing LLCs will be assigned to the limited partnership.
One of the benefits of the limited partnership format is the opportunity to eliminate the need to contribute to FICA and Medicare due to a special provision in IRC Sec 1402(a) which exempts limited partners from FICA and Medicare taxes. Over the course of a business career, the level of FICA/Medicare savings invested at over twenty-five years at 7 percent amounts to a significant amount approximately $1.4 million over that time.
The asset protection benefits of the structure are powerful. Each separate business or real estate activity should be owned within separate LLCs. Following the assignment of LLC interest, these single members LLCs would be wholly owned by the limited partnership. Single members LLCs are not required to a separate tax return as a disregarded entity. The only reportable item is the net income or loss. The C corporation functions as a management company. One planning measure for consideration is the transfer of the personal vehicle that you own or lease to the corporation. Following the transfer of the vehicle, the vehicle becomes a company owned car making all of the expenses associated with the vehicle deductible.
Another planning benefit is the possibility of creating staggered year ends. The corporate general partner may elect a corporate year end that is not a calendar year end (12/31). A staggered year end electing a fiscal year end of 11/30 provides an opportunity to defer income is to have the limited partnership to pay income received in December to the corporate general partner. This structure will provide the ability to defer the payment of taxes until the tax due date of the corporation which is three months after its year end. A corporation may also have a filing extension for an additional six months. The stagger in this scenario increase the filing time period until September 15 of the following tax year.
Good liability planning for the business suggests the transfer of employees for the businesses into the management company. This planning separates any of the employment related liabilities from assets of the company. The planning structure also creates the opportunity for income shifting to children or elderly relatives.
Regular (C) corporations provide a more favorable structure for employee benefit purposes. For example, the management company which serves as the general partner of the limited partnership may create a Section 105 provides a tax deductible vehicle for the business owner to pay or reimburse medical expenses for the business owner on a tax deductible basis without incurring tax deductible treatment.
Summary
Currently, millions of existing business owners are tied to less than optimal corporate structures. These business owners should consider a corporate reorganization to achieve the corporate, tax and asset protection benefits of the structure discussed in this article. The structure simplifies while providing significant financial and tax benefits without any loss of control. Lastly, I won't wait four and a half years for the next segment in this series. Promise!