Thursday, July 15, 2010

Another reason to Beware of LLC’s

Still getting advice to form an LLC?

Lawyers accountants and business advisors still routinely suggest most small start-ups form an LLC and they even fill out the forms to do it. LLC’s and S-corps almost never give the benefits of a C-Corp in tax deductions, withholding of assets, employment plans for health, education and retirement, Etc.!!! I have already blogged against the “llc one size fits all” practice below and will not repeat all that here. But there is MORE. An LLC may be even worse than a sole proprietorship or family partnership business!

Hiring Family Members in a Family Business

In today’s tough job market a family business may be the only place for some family members to find work. Rather than supporting them you can hire them and pay them with tax-deductible dollars for legitimate work with pay reasonably commensurate with the hours and job.

If you employ a child(ren) under the age of 19 or a student under age 24 who is claimed as a dependent of the parent, his earned income is taxed at the child’s marginal rate, and the earned income is reduced by the lesser of the earned income plus $300 or the regular standard deduction, $5,700 in 2010. Assuming that a child has no other income, the child could be paid $5,700 and incur no income tax. If paid more, the next $8,375 earned by the child is taxed at only10% . This is almost always far less than the parent’s rate if you simply paid the child an allowance, college fund or other savings after paying your own taxes on the same money! Plus you could put even more earned and currently untaxed money in the child’s deductible IRA and any qualifying, deductible College fund from the child’s earned income. Make the tax man subsidize your child rearing budget even more!

Remember, a child’s investment income can still be taxed at the same rate as the parent’s top marginal rate using a lower $950 standard deduction. Most would be better off putting their money in a business and hiring the kids rather than creating trusts or gifting then Investing for them and paying a high marginal rate.

All of the above is available whether you incorporate or not, use an S-Corp, C-Corp or LLC. Here is the kicker and why an LLC can be worse than no corporate business entity at all: FICA and FUTA!

If the business is unincorporated and the wages are paid to a child under age 18, he or she will not be subject to FICA – Social Security and Medicare taxes since employment for FICA tax purposes doesn’t include services performed by a child under the age of 18 while employed by a parent. Neither the employee’s (Child’s) share of the FICA taxes or the business half need to be paid: roughly 18% of the total child’s income saved! In addition, by paying the child and reducing the business’s net income, both the parent’s Income Tax and FICA on net self-employment is also reduced.

An even more liberal exemption applies for FUTA, which exempts a child under age 21 from federal unemployment tax while employed by his or her parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting solely of his parents.

These exemptions do not apply to businesses that are incorporated including LLCs or a partnership that includes non-parent partners. Did the guy who set up your LLC even ask if you would be hiring the kids????? I doubt it.

Land Trusts for the Real Estate Investor

I recently received an Ad concerning the 7 reasons to use a Land Trust from a real estate site. A land trust is a revocable, living trust used specifically for holding title to real estate and can be a powerful tool for holding investment real estate. The land trust is a very powerful tool for the savvy real estate investor. Each property is titled in a separate trust, affording maximum privacy and some protection. As a “revocable” trust, it is not a perfect Asset protection vehicle because it is still subject to seizure upon judgment against the person with the power to revoke. But there are benefits. I heartily agree with 5 of the seven ( watch out for the last 2).

1. Privacy. Privacy is extremely important to most people but anyone with an internet connection can look up your ownership of real estate. Land Trust ownership may make it harder for someone suing you or even city code enforcement to find who the owner is, since the trust agreement is not a public record.

2. Protection from Liens. Real estate titled in a trust name is not subject to liens against the beneficiary of the trust. Personal judgments or liens of the seller may not attach to the property effectively separating the owner or seller from the property.

3. Protection from Title Claims. If you sign a warranty deed in your own name, you are subject to potential title claims against you if there is a problem with title to the property (Indian Claims in CT for example). You warrant and agree to Defend the title in a warranty Deed. A land trust as seller will protect you personally against many types of title claims because the claim will be limited to the trust. If the trust already sold the property, well, no assets either!

4. Discouraging Litigation. People tend to only sue those who appear to have money. Attorneys who work on contingency need to collect. If your investment properties are hard to find, you will appear less worthy of suing

5. Protection from HOA Claims. When you take title to a property in a homeowner’s association (HOA), you become personally liable for all dues and assessments. With a condo in your own name the association can lien the property and/or sue you PERSONALLY! With a land trust, the trust is the sole recourse for the homeowner’s association’s assessments and debts.

6. Making Contracts Assignable. The ownership of a land trust (called the "beneficial interest") is assignable, similar to the way stock in a corporation is assignable. Once property is titled in trust, the beneficiary of the trust can be changed without changing title to the property. This can be very advantageous in the case of a real estate contract that is non-assignable, such as in the case of a bank-owned or HUD property. Instead of making your offer in your own name, make the offer in the name of a land trust, then assign your interest in the land trust to a third party. BUT There is always the danger of being charged with a conspiracy to defraud, especially if this becomes a regular practice.

AND be very careful about this one!!!!

7. Making Loans "Assumable". A non-assumable loan can become effectively assumed by using a land trust. The seller transfers title into a land trust, with himself as a beneficiary. This transfer usually does not trigger the due-on-sale clause of the mortgage. After the fact, he transfers his beneficial interest to you. This latter transaction does trigger the due-on-sale, but such transfer does not come to the attention of the lender because it is not recorded anywhere in public records. This effectively makes a non-assumable loan "assumable". CAREFUL!!! THIS CAN BE, at least, CLOSE TO (bank) FRAUD, also, if you are the seller of a property with a mortgage, remember YOU SIGNED THE NOTE. If the buyer, your assignee, takes out a big 2nd mortgage or big insurance policy and the house “accidentally” burns down; he goes to Brazil while the bank sues you on the note.

There you have it, Real estate trusts can be very useful if you know their limits. An Irrevocable trust made to your Family Limited Partnership can be even more effective from an asset protection viewpoint.