I have been pontificating ad nauseam some readers might say, on the benefits of structuring a family business and investment holdings in my recommended version of the ideal corporate set up. My recommended structure is the formation of a new family limited partnership (LP) using a general partner that is structured as a regular corporation. In certain instances, we might be flexible and suggest structuring the general partner as an LLC since it previously noted that I disfavor S corporations generally.
The taxpayer following the creation of this family business corporate structure transfers through assignment, business holdings and investment holdings typically owned in separate LLCs to the new LP. The LP has a calendar year end, and the corporate general partner has a fiscal year end - say November 30th. This stagger creates a tax deferral opportunity within the corporate general partner.
This structure has several important management, asset protection and tax benefits. First, the separate business and investment holdings are segregated from each other, isolating each entity from the liabilities of each separate business and investment activity. Second, each entity starting at the LP level, has charging order protection. Think of it as a big envelope holding several separate envelopes each with separate contents. If you manage to open the larger envelope, you still must pry open each separate envelope to reach the contents of each envelope. Third, the staggered year end creates a significant tax deferral opportunity through the payment of a management fee to the corporate general partner by the LP. Fourth, the current top marginal tax bracket for a regular corporation is much lower than the top marginal tax bracket for individual taxpayers. California and New York residents, are you listening? Lastly, the corporate general partner but importantly, the taxpayer retains management and administrative control over the LP's entities.
This article picks up on the point that the corporate general partner is an ideal entity to structure employee benefits - pension and healthcare. I have previously articulated the point that every taxpayer is potentially a business owner, an accidental entrepreneur, even if the corporate employee that owns a few rental properties and a stock portfolio.
This article focuses on the creation of a family pension plan and the addition of children to the corporate payroll and participation in a corporate retirement plan structured as a Roth Plan. If you are going to create a savings plan for children and yourself, why not use it with a tax advantage with expanded contribution limits?
Oh, The Places You Will Go!
I must admit that when my three daughters were growing up, I purchased each of them the Dr. Seuss classic, Oh, The Places That You Will Go, on the occasion of their high school graduation. I also admit that I am more sentimental than I realized. It was their graduation but personally I felt the theme of the book inspired the same promise and hope of a great future full of adventure within me. It resonated with me more than it did with them. My mother (of blessed memory) use to frequently say in adverse situations, "This too shall pass."
The planning strategy in this segment focuses on the idea calls of adding the taxpayer's children and spouse to the payroll. As a regular corporation, the corporation has a withholding obligation for FICA and FUTA purposes on children under the age of 18. The standard deduction for an individual taxpayer in 2020 is $12,400 meaning a child does not have to file a federal tax return until his income exceeds this level.
However, if the corporate general partner is an LLC taxed as a sole proprietor or partnership, the FICA and FUTA obligation on minor children employed by the corporate general partner is eliminated at the general partner and employee level. So, in this case, we modify our ideal corporate structure to include the use of a general partner structured as a LLC to avoid the FICA and FUTA withholding obligation while paying the children a salary that is within the standard deduction and not subject to any withholding obligation. Hence, no federal or state income taxation is due on the salaries to minor children along with no FICA and FUTA withholding.
The Family Pension Plan
One of the benefits in the creation of a corporate general partner is the ability to create a qualified retirement plan within the corporate general partner. This plan can include a cash balance defined benefit plan and 401k/profit sharing plan. These contributions use tax deductible contributions to the corporation. The benefits provide tax deferred benefits that are taxable as ordinary income upon distribution. One qualified plan solution that is much simpler and less costly for administrative purposes is a 408(k) which offers greater flexibility for an expanded list of exemptions for the early withdrawal penalty.
The 408(k) is like a Roth 401k component but is created under a Salary Reduction Simplified Employee Pension Plan. The 408k has greater flexibility in the number and types of early distributions that are exempt from the early withdrawal penalty under IRC Sec 72(t). An individual Roth IRA has an annual contribution limit of 6,000 which is increased to $7,000 for a taxpayer who is age 50 or older. The individual IRA is also capped by the taxpayer’s income. Taxpayers filing a joint return with more than $206,000 of adjusted gross income (AGI) cannot make a Roth contribution. For single taxpayers, the income limit is $139,000.