I have been pontificating ad nauseam some readers might say, on the benefits of structuring a family business and investment holdings in the ideal corporate set up. My recommended structure is the creation of a new family limited partnership (LP) with a general partner that is structured as a regular corporation. The taxpayer follows up the creation of this family business corporate structure with the transfer through assignment, of business holdings and investment holdings 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 structure has several important management, asset protection and tax benefits. First, all of 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 a number of separate envelopes with its contents. If you manage to open the larger envelope, you still have to pry open each separate envelope.
Third, the staggered year end creates a significant tax deferral opportunity through the payment of a management fee to the corporate general partner. 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 retains the management and 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 the corporate employee that owns a few rental properties and a stock portfolio.
This article focuses on the creation of a family pension 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 have to admit that when my three daughters were young, I purchased each of them the Dr. Seuss classic, Oh, The Places That You Will Go, at the occasion of their high school graduation. I admit that I am more sentimental than I realized. It was their graduation but personally I felt the theme of the book inspired the promise and hope of a great future full of adventure that 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 strategy calls for adding the taxpayer's children 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 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 can be eliminated at the general partner and employee level. So, in this case, we modify our ideal structure to include the use of a general partner structured as an LLC to avoid the FICA and FUTA withholding obligation while paying a salary that is within the standard deduction. 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. A 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 401k component may be structured as a Roth 408k plan under a Salary Reduction Simplified Employee Pension Plan. An individual Roth IRA which 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 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.
These income and contribution limitations disappear for a Roth 408k Plan. In 2020, the contribution limit to a Roth 401k is $19,500. A taxpayer who is age 50 or older can contribute an additional $6,500 to the Roth 401k for a total contribution of $26,000. At a minimum, every taxpayer of reasonable means should create the proposed corporate structure to add a Roth 408k. A couple can double the benefit. A couple can also begin this process for the children and grandchildren.
IRC Sec 529 provides an excellent vehicle for accumulation funds for higher education. The cost of undergraduate education at a private university with room and board can average $200,000- 250,000. 529 plans allow for the use of after-tax dollars that can be invested without taxation and then distributed tax-free for qualifying expenses such as tuition, room and board, books, and the repayment of student loans. the 529 plan does not provide any benefits beyond qualified higher education costs.
The Roth 408k provides similar benefits with greater flexibility to provide benefits with the possibility of early distributions before age 59 1/2 without penalty. These exemptions include early distributions for death, disability, qualified higher education expenses and first-time home buyers. The taxpayer can also take early distributions for the payment of medical expenses that exceed ten percent of adjusted gross income.
Summary
The deeper we dig into the possibilities of the ideal corporate structure; the planning jewels appear at the edge of the surface. The ideal corporate set up creates an avenue to make the benefits of Roth planning available for every taxpayer (I did mean to say every!) with annual contribution limitations that are three times the contribution limit for an individual without income limits. The list of planning benefits for adopting the ideal corporate structure continues to expand. Stay tuned for the next installment.