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.

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