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Snake
Oil Strategies Proposed by Others
That Just Simply Don’t Work!
We are in an industry where misinformation runs
rampant. Our goal is to uncover strategies that are simply not true.
On the surface many of these strategies may seem to save you tax dollars
and are appealing.
Rental Property Owners
You often hear that C-Corporations at $50,000
in net profits will only pay 15% Federal Income Tax. That is true. One
part is left out. Unless you live in a state with no state corporate
income tax, like Wyoming, Nevada, South Dakota, Washington* or Texas*,
you will also have to add in your home state corporate income tax. Assuming
you are the employee of the corporation. You would register in the state
where the work is being accomplished. See our extensive information
concerning nexus and having to register as a foreign corporation in
your home state. Many companies will promote a strategy to retain profits
in the corporation to put you into the 15% tax bracket.
* Texas has a franchise tax that is high, Washington
has a B & O tax. Both are in place of a state corporate income tax.
A closer examination will reveal these strategies
pick your pocket book. They don’t lower your taxes.
For example, one such strategy suggests that if
you have passive income from rental properties of $100,000,in an LLC,
it can flow through to two Nevada corporations. If the LLC is taxed
as a partnership, yes the money does flow through. The strategy then
suggests that magically, this passive income converts to active
income for each corporation (Rental income is typically passive income,
and as it flows from the LLC into the corporation it is passive income.
Under the definition of Personal Holding Corporation Income (Code Sec.
543) – rents are a part of this income). And you pay only 15% Federal
Income Tax on that income. Of course these strategies leave out your
state corporate income taxation, (unless you worked in one of the states
above mentioned). We would find comfort if you were told this at some
point. By the way, income can not convert from passive
income to active income by going to a corporation.
First, why is it important to have active rather
than passive income in the corporation? Because if the income was passive,
and there was not at least 41% active income from other sources, the
corporation would be deemed a Personal Holding Corporation and
would have to pay an additional 39.6% tax on any undistributed
profits! That is on top of the corporate tax rate. In other words, in
this example, there would be a corporate tax rate of 15% plus 39.6%
or a total of 54.6%. Is that a tax savings program? Actually, it gets
worse. Odds are these two corporations will be a controlled group. Instead
of paying 15% tax, you would pay 22.5% tax plus the 39.6% or a new grand
total of 62.1% tax. Of course, this doesn’t not take into consideration
penalties and interest after the IRS catches this little scheme about
3-4 years after you spent all the money!
The same is true of trading stock. This passive
income will not magically transform into active income in the corporation.
It is passive, plain and simple.
Multiply Entities
There are many companies that suggest having your
income split into two separate corporations. The theory is if you earn
$100,000 in net profits in one corporation, instead of paying 22.5%
tax on that, if you split that income into two corporations you could
pay only 15% times $50,000 in net profit in each corporation and save
$7,500! Of course, as the saying goes, if it sounds to good to be true
it probably is. Typically, we are talking about a corporation where
you control the stock ownership. Usually you will have a controlled
group problem, which means someday, when you get audited, you will
owe a lot in back taxes and in penalties and interest. A long story
short, this doesn’t work either.
The Two Corporation Strategy
It is interesting how some companies actually
admit there are situations when you have to register as a foreign corporation
in your home state. This typically comes into play to help promote another
favorite Nevada strategy (keep in mind many companies promote these
same strategies with Delaware, Wyoming and South Dakota corporations).
Basically, the corporation that is operating in your home state will
lease its equipment from a corporation operating in a state income tax-free
locality like Nevada. This means the corporation operating in your home
state has assets like equipment, computers and fax machines and they
are either transferred or sold to a second Nevada corporation. The objective
is to take profit out of your home state corporation and move it to
Nevada to save state corporate income taxes. This does not work for
several reasons:
- Assets like equipment and computers create
nexus where they are located. If were to ship all your equipment to
Nevada, how are you going to use it? Of course, they don’t tell
you to move the equipment to Nevada, just the invoices. Again, the
domicile of the equipment is where nexus is created; therefore the
Nevada corporation will have to register in your home state. So, much
for the state corporate tax savings.
- Again, you will more than likely have a controlled
group problem. Meaning, you will have a more complicated tax return
and only one tax bracket, not two.
- If the assets where actually in Nevada, where
is your employee in Nevada doing the work for you? There is none.
Again, this corporation would have to register in your home state.
If you actually leased equipment from another
company that you did not own, like the local computer store, yes you
could lower your state corporate income tax, because you don’t
own the equipment and most of your profits would go to pay the leases!
If you actually want to protect these safe assets
you would want to put them into a separate entity, but an LLC, not a
corporation.
Trading through a Corporation
The next common strategy we hear is the one where
you do all your trading through a corporation and don’t have to
pay state corporate income taxes because you have a Nevada corporation
and you have an office and bank account in Nevada. Again this doesn’t
work. The key question is from where is the work being controlled?
Yes, they will tell you that trading can be based from anywhere, but
where did you actually trade? Was it in Nevada, your home state, the
North Pole? Obviously, you are doing the trading from your home state,
and since all corporations must have one employee that means you must
do payroll. Payroll is done in the state where the work is controlled.
That means this Nevada corporation must register to do business in your
home state, so for 46 states you need to add your state corporate income
tax to this strategy. Again, it doesn’t turn out to be as good
as it first appears. The bigger problem here is that if you do not qualify
as a trader the corporation will be viewed as a personal holding corporation,
and if you do qualify as a trader you will be veiwed as a personal service
corporation which pays an ADDITIONAL 39.6% on any undistributed profits.
Operating as a Nevada Corporation
vs an
Independent Contractor
We agree that you should never operate as a sole
proprietor. You can easily save some self-employment taxes by becoming
an S corporation and have some liability protection with no downside.
Or you may choose to become a C-corporation to take advantage of fringe
benefits or lower C corporation tax rates. What isn’t true in this
common example, is when the corporate tax rate is added in for the Nevada
corporation, they forget to tell you to register in your home state
as a foreign corporation (unless you live in Nevada, assuming you are
the employee). Again, unless you live in a state with no state corporate
income tax you will need to add your state corporate tax rate to the
equation. As a sole proprietor you have to add the SE taxes of 15.3%
up to $76,200 this year. This will save you taxes, but the math is wrong
on how it is calculated. Just remember to register where you have nexus
as a foreign corporation.
Please visit our site often as we uncover the
"snake oil" strategies that simply do not work.
- This research
attempts to answer the question of whether or not a state
can apply its own law regarding piercing an entity to so-called "pseudo-foreign" corporations.
