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SnakeOil 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:

  1. 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.
  2. 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.
  3. 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 $113,700 in 2014. 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.

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Snake Oil Strategies Proposed by Others That just Simply Don't Work - The most important article on this site!

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