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In this episode of Practical Tax, tax attorneys Steve Moskowitz and Cliff Capdevielle discuss the benefits of choosing a Limited Liability Company (LLC) as your business entity.
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Episode Transcript
Intro:
You’re listening to the Practical Tax podcast with tax attorney Steve Moskowitz. The Practical Tax podcast is brought to you by Moskowitz LLP, a tax law firm.
Steve Moskowitz:
Hello, and welcome to everyone to our podcast about practical tax. And today we’re gonna be talking about LLCs and all the benefits they have for you, we’re gonna be talking about asset protection, because unfortunately in our society, a lot of people that don’t have what you have wanna take it away from you in a lawsuit. We don’t want that to happen, and we’re gonna explain how you protect against that. And also we’re gonna ask you the tough question; if you have the legal choice to pay taxes on either 80% of your profit or 100%, which would you choose? And all kinds of other benefits. On that happy note, I wanna to turn it over to my friend and colleague, the head of our tax department, tax attorney and accountant, Cliff Capdevielle. Cliff, take it away.
Cliff Capdevielle:
Thanks Steve. One of the first questions we get from new clients and often from existing clients is, “What’s the best entity structure for me?” And it seems like a simple question but there’s a lot to it. So, should you be a partnership, an LLC an S-corp or a C-corp? Oftentimes clients come in and they’re operating as a sole proprietorship. Sole proprietorship is simple and easy but it’s fraught with a lot of problems. The sole proprietorship is essentially you doing business in your own name, or as a DBA. And while it’s simple, it doesn’t add much in terms of asset protection. So, if you have a claim by a creditor, a vendor, anyone, your personal assets are exposed and that’s why we-
Steve Moskowitz:
I have a question about that. Suppose you have a woman and has a business and she’s in sole proprietor and her husband is a house husband, does that mean if the plaintiff would actually win, they can take assets away from her husband.
Cliff Capdevielle:
That’s right, they can take the assets that are unrelated to the business. And that can be assets that have been in the family for years, totally unrelated to the business at all.
Steve Moskowitz:
That is not gonna make a happy marriage.
Cliff Capdevielle:
Not at all. So, we almost always recommend that an operating business choose a pass-through entity structure of some kind, an S-corp or an LLC. We occasionally will recommend a C-corp structure if the client is intending to raise money from professional investors, because the C-corp has the advantage of allowing different types of shares preferred in common.
Steve Moskowitz:
Cliff, I have a question about that.
Cliff Capdevielle:
Yeah.
Steve Moskowitz:
Suppose somebody chooses a C-corp, ’cause you see, their plan is to work the business for a while and then sell it, will there be any advantages to selling the shares of a C-corp?
Cliff Capdevielle:
Sure, it depends on what type of entity is, but the tax code does provide substantial tax benefits for startups, we see this all the time, Section 1202. Stock allows startups to sell up to $10 million, in some cases tax free and that’s a huge tax-
Steve Moskowitz:
Wait a minute, $10 million dollars tax free? I bet that got our list of attention. Folks, how would you like to sell $10 million tax rate? And that’s one of the reasons I became a tax lawyer. Look at the Fortune 500. They make billions of dollars in taxes, excuse me, they make billions of dollars in profits, and some of ’em legally don’t pay a penny in taxes. How is that possible? ‘Cause they have an army of people like Cliff and Liz and our colleagues and me, saying, “Hey, do this and do that.” And that could make such a difference in your life. Imagine that. Getting up to $10 million tax free, and as you know, I get really excited about saving taxes and that’s just one of the examples.
Cliff Capdevielle:
Yeah, absolutely, Steve. So for those startups, the tech companies in Silicon Valley, that’s a huge advantage. Just yesterday I was working with a very hard working guy who’s sold a bunch of his startups stock, and he’s gonna put 10 million bucks in his pocket tax free, so he is a happy camper.
Steve Moskowitz:
Nice, and that’s all part of tax planning?
Cliff Capdevielle:
Absolutely. Most of our clients are not the big Fortune 500, we work with mainly smaller companies, and the structures that we usually recommend are the S-corp and the LLC or limited partnership. Today we’re gonna talk mainly about the LLCs and the limited partnerships. Those typically, are used for investments. In other the words, if you have for example a family limited partnership owns a number of apartment buildings, they can use the limited partnership structure to legally protect those assets from creditors. If you have a tenant who falls down the stairs or you have a vendor who makes a claim against you, the other assets of the family limited partnership can be protected. We set up those rental properties in separate limited partnerships, is the common way we do it.
Steve Moskowitz:
Cliff, let’s focus on something here for a second. Suppose we had a situation where we had a client who had 10 rental properties, and I realize we’re gonna be speaking California specific in a moment, but this would apply to similar things in other states, you’d have to check the actual state law here. But suppose we have to say, “Well there’s a franchise fee here for the privilege of being an LLC and in California it’s $800,” actually I have 10 different entities, I don’t wanna put multiple entities in… Actually I don’t wanna put multiple real properties in one entity ’cause that defeats the asset protection, because we’re compartmentalizing, we’re putting each asset in its own entity so that we don’t lose the others if something goes wrong. Is there some way we could save those franchise fees? ‘Cause I don’t feel like paying eight grand in franchise fees.
Cliff Capdevielle:
We did get a recent ruling that’s now almost two years old. The Franchise Tax Board has conceded that in the case of multiple limited partnerships that have the same ownership, which is typically the case of family limited partnership, you can pay just one franchise tax fee of $800 by the general partner, which is usually an LLC, and then those other limited partners and limited partnerships can avoid that $800 franchise tax fee which is such an annoyance in addition to being a tax burden.
Steve Moskowitz:
So you’re looking to save taxpayers both the big bucks and the smaller bucks? It’s all about saving money.
Cliff Capdevielle:
Absolutely, so we’re always looking for those tax-saving opportunities and that’s one of the recent ones.
Steve Moskowitz:
And Cliff, we wanna give an incentive to our listeners to listen to the podcast we did on S-corps. So let’s just have a real short teaser on how we could use an LLC to pay taxes on 80% of our profit instead of a 100. But folks, if you wanna hear it in more details, listen to us in the S-corp. Cliff?
Cliff Capdevielle:
Yeah, absolutely Steve. So, probably one of the major benefits from the 2017 Tax Cut and Jobs Act is what’s called the qualified business income deduction. That is a way for pass-through entities like LLCs and partnerships to pay tax on only 80% of their net income. It’s a huge benefit. It was an attempt to sort of level the playing field with the C-corps, which received a big tax cut in the year 2017 Tax Cut and Jobs Act. So, that’s something we do a lot of planning around, and certainly if you meet the qualifications, that qualified business income deduction as you say, can be up to 20% tax savings off the top.
Steve Moskowitz:
So Cliff, you’ve told us about asset protection, that’s fantastic. You’ve told us about only paying tax on 80% of your profits instead of the normal 100%. But are there any other benefits in being an LLC for example with a pension? Would a benefit be there with an LLC?
Cliff Capdevielle:
Yeah, so there are a couple ways to structure this, retirement plans are certainly one of the major tax-saving opportunities that we talk about. If you have an LLC, typically what we do to maximize the pension plan deduction is that we have you report as an S-corporation, there’s certain advantages of that. Most importantly, if you make the S-election as an LLC, then you pay tax, the self-employment tax on only that portion that’s paid out to you as wages. And in addition, you can use those wages to fund a pension. So, if it’s an operating business and you have earned income from the business, then we can use that income to fund a pension. Alternatively, we can set up an operating company, a separate LLC to manage the properties, for example, if they’re in limited partnerships or LLCs, and then in turn use that money that’s earned as management fees to pay salary to the owners and then use that salary to fund a pension plan. And that’s a huge tax-saving opportunity.
Steve Moskowitz:
Yes it is, and cliff, tell me, have you ever been in this situation where somebody comes in the office and says well, “I don’t own a business, I’m retired, or I’m a wage earner, I just have some investments in crypto, I have some investments in stocks and bonds, or real property,” would there be some way to use this entity to our advantage?
Cliff Capdevielle:
Yeah, we do that all the time. So, people who are retired or semi-retired for example, are managing properties, and one thing you can do, you can convert essentially the LLC income to earned income, and use that earned income to fund the pension. So, essentially the people who own the properties are earning management fees through an S-corp typically, and then turning around and funding the pension plan with that W2 income.
Steve Moskowitz:
Cliff, that’s fantastic. And I think what I heard was you said that without this entity somebody wouldn’t be able to offset this investment income with a pension. But with the entity, after the smoke clears, they effectively could, is that right?
Cliff Capdevielle:
That’s right. So, most people, if they own a rental property for example, in their own name, it’s on a Schedule E, and that’s considered passive, so that is not typically eligible to fund a pension. But there’s a way to structure these entities such that they can fund a pension. And really that’s because of course it does require often substantial effort to manage properties.
Steve Moskowitz:
So that’s terrific because essentially what we’re saying is, this enables the client to pay less taxes and put more away from the retirement. To me that’s a no brainer.
Cliff Capdevielle:
Yeah, absolutely, Steve.
Steve Moskowitz:
Now… Go ahead.
Cliff Capdevielle:
Yeah, I was gonna say, let’s just talk a little bit about the new AB 150 and SB 113.
Steve Moskowitz:
And for those of you who are listening in other states, almost half the states have enacted something similar to that. So, we’re gonna explain to you the California version, and if you’re another state, take a look to see if there’s a version in your state. Go ahead, explain it to us, Cliff.
Cliff Capdevielle:
Yeah Steve, so this is what’s called the SALT tax workaround, the state and local tax workaround. This is in reaction to a change in law in 2017 that limited the federal deduction for state taxes to $10,000 per year-
Steve Moskowitz:
And that really is hurtful because for a lot of people, that was their biggest deduction.
Cliff Capdevielle:
Absolutely, in high-tax states like California and New York, was absolutely the best tax deduction out there, and when that was taken away, we saw a lot of people pay a lot more in federal income tax. So this is a new workaround in California, and the way that it works is if you pay your tax through the entity, it can be an S-corp, an LLC or partnership, and you pay that tax on or before March 15th, you’ll get a credit against your other tax. In other words, even though you’re not allowed to deduct this on Schedule A anymore, you can still get a benefit of up to 9.3% of the net income of the business. So this is a big deal. And we’re getting a lot of questions on it, but it’s certainly not too late, and if you wanna call us to talk about it we’re happy to do that, but you do need to complete this transaction before March 15th.
Steve Moskowitz:
So Cliff, if I’m hearing this right, if somebody was a sole proprietor before, they’re limited in deducting their state taxes to $10,000 on their federal return. But if they form an entity like an LLC, an S-corp or other qualified entity, that they can deduct a much larger amount because they’re an entity? That’s just fantastic. You get to deduct more of the money you’ve already paid to the state anyway.
Cliff Capdevielle:
Yeah absolutely Steve, it’s a huge tax break and everybody who’s eligible should take advantage of this. The Franchise Tax Board does have a new website, and a way to pay this online. You do have to pay it through the entity and it does have to be paid before March 15th, but it’s absolutely a huge tax savings for many people.
Steve Moskowitz:
Now Cliff, this just sounds so tremendous. Is the state here being even more generous that they recently modified this in favor of the taxpayer?
Cliff Capdevielle:
Yeah, So there are two laws, the AB 150, and now the SB 113 which slightly modified it. The pushback that the Franchise Tax Board had was potentially, this SALT tax workaround could be dramatically limited by the alternative minimum tax. And so that problem was fixed in this SB 113, and so now this tax benefit is even better. So we are encouraging all of our clients who have S-corps or LLCs, other partnership, flow-through entities to take a good look at this, and if it benefits you, just make sure that tax is paid before March 15th.
Steve Moskowitz:
And Cliff, when we talk about tax we get so excited, that time just flies in an instant. But it looks like it’s getting close to wrap time. Is there any final thought you wanna give us on this?
Cliff Capdevielle:
Well yeah, so the other issue that we have, for partnerships and LLCs, the big news this year, Steve is the change in these partnership audit rules. And these are very complicated and we are encouraging all of our LLC partnership owners to give us a call, and let’s take a look at your partnership agreement, make sure that it’s drafted in a way that benefits you and doesn’t put you in a bind with regard to these new partnership audit rules. For example, the big change is that instead of audits at the individual partner level, we now have partnership level audits. Well, what’s the big deal with that? The big deal is that if you’re new to a partnership, you may get stuck paying the tax of a partner who left years ago. That’s because the assessment is now at the partnership level and unless your partnership agreement is drafted in a way to protect you, you could be paying tax for somebody else.
Steve Moskowitz:
And that’s why it’s so clearly important if you go into an established partnership as opposed to starting a new one, that you have us counsel you to avoid these problems.
Cliff Capdevielle:
Absolutely. It’s a good idea from an asset protection point, and also in terms of estate planning. We do a lot of work with families using family limited partnerships, LLCs, to make gifts, and it is very powerful. We don’t have time to dig again into details, but because Congress has not yet acted to reduce the gift tax exemption, or the estate tax exemption, it’s possible still to give almost $12 million dollars to your kids or your grandkids absolutely tax free. And we can use limited partnerships and LLCs to create discounts where you can even give more than that, and dramatically reduce gift in estate tax to families who are planning.
Steve Moskowitz:
That’s fantastic Cliff, and although our time is up, it’s now up for you folks. If you’d like to talk to Cliff or me or other members of our firm, all that you have to do is give us a call 888-tax deal. That’s 888 T-A-X D-E-A-L. 888 tax deal, or moskowitzllp.com. M-O-S-K-O-W-I-T-Z llp.com. And our last advice of this podcast is to keep tuning back. There’s so many subjects that I find fascinating, I’m sure you will too because this is your chance to take advantage of the tax laws like the big corporations do. Find out if you can do it for a small and medium sized business. On that happy note, we’ll look forward to seeing you next time.
Outro:
You’ve been listening to the Practical Tax podcast with tax attorney Steve Moskowitz. To hear more podcasts, go to moskowitzllp.com/practical-tax The information contained in this podcast is based on information available as obtained at the date of its release. Moskowitz LLP and its affiliates are under no obligation to update this information as changes occur. Applying this information to your specific situation requires careful consideration of all factors which may be applicable. And any information is not to be considered tax advice or legal advice. Further, this is attorney advertising, and the facts and circumstances displayed in this case are dependent entirely on the facts of that particular case. Please consult your tax advisor before acting on any matters discussed.