LLC or S Corp

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Question from a reader: Structure of a business as LLC or S Corp. I would like to know what is betther for a clothing company LLC or S Corp? Which are the benefits and disavantages of each option?

It appears that you have done your homework and is narrowing down your decision to two choices: LLC or S-Corp.

When making your selection there are several significant areas for considerations- a) employment tax, b) liabilities, and c) ease of operation.

a) Employment Tax: A major factor is taxes paid on earnings. The owner of an LLC is considered to be self-employed. Consequently, the entire net income from your earnings is subject to the 15.3% in “self-employment tax” which goes toward social security and Medicare.

In an S corporation, only the salary paid to the employee-owner is subject to employment tax. The remaining income is subject to income tax but not employment taxes.

b) Liabilities. We live in a litigious society. A LLCs generally will give you superior liability protection than a S-Corp.

c) Flexibility in ownership and ease of operation. There are no restrictions on the ownership of an LLC. An LLC is simpler to operate because it is not subject to the formalities by which S corps must abide.

There are additional factors which could impact your decision: investment in real estate or other passive investments, multistate operations, number of owners.

These are general comments. You should discuss your specific legal issues with your personal attorney.

Vacation Homes, Timeshares

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Categories:

  1. Personal-residence rules: Properties rented 14 days/year or less;
  2. Personal-residence rules: Properties rented > 14 days/year and is less than personal use days.  Personal use days = max(less than 14 days, 10% of the rental days)
  3. Rental property rules: Properties rented > 14 days/year and is greater/equal to than personal use days.  Personal use days = max(less than 14 days, 10% of the rental days)

Examples:
a. Rent for 210 days and vacation for 22 days, then you’re under the personal-residence rules.  (rental, 210days x 10% < vacation, 22 days)

b. Rent for 210 days and vacation for 21 days, then you’re under the rental property rules. (rental, 210days x 10% >= vacation, 21 days)

Timeshares

  • If you use your timeshare yourself and not rent it out, then deduct your share of the mortgage interest (as interest on a second home) and the property taxes on Form 1040, Schedule A.
  • If you rent out the unit a portion of the time, the correct tax approach is to allocate expenses based upon personal and rental use by all owners. If these figures are difficult to obtain then use your best guess as to a reasonable allocation, e.g. 50%, and follow the personal residence rules. This approach will permit you to deduct the personal portion of the mortgage interest (as interest on a second home) and the property taxes on Form 1040, Schedule A.

Variable-annuity, with Guaranteed Lifetime Withdrawal Benefit

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Guaranteed Lifetime Withdrawal Benefit (GLWB) is not a stand-alone product but is a rider attached to a variable annuity insurance product.

How does it work?

The GLWB allows the annuitant to withdraw a fixed percentage of the total annuity premiums each year regardless of market performance. The income payments are guaranteed for life.

Example.

Bob, the annuitant, buys a variable annuity for $200,000 with a GLWB rider that pays 3% annually. The stock market had declined sharply during the past 10 years and the annuity is now worth $150,000. Bob will receive $6,000 per year for the remainder of his life ($200k x 3%). The guarantee is computed on the initial investment ($200,000) and not on the declined portfolio value ($150,000).

This product sounds like a winner. The annuitant receives downside protection through lifetime income and upside potential based on market performance. Not so fast. While the guarantees is favorable in a bear market by shifting the risk from the annuitant to the underwriter, this product comes with a cost.

The problems.

  • The income received will not protect the annuitant against inflation.
  • The fee structures is frequently complicated and expensive.

When does this product make sense?

  • It permits the retirees to have a peace of mind without worrying about stock market conditions.
  • It is helpful if the retirees have limited access to other guaranteed income sources (e.g. corporate defined-benefit plan).

When to avoid this product?

  • If the retirees have other guaranteed income sources (e.g. corporate defined-benefit plan).
  • If one expects inflation is to rise in the near future.

Different Tax Treatment of Economically Equivalent Portfolios

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On December 2, 2011, The Joint Committee on Taxation released a report on income tax treatment for different financial instruments and products.

Thomas Barthold, chief of staff of the joint committee testified “While the underlying economics of two different financial situations may be identical, the tax treatment under the present law may not be equal”.

Mr. Barthold gave the example of two portfolios. Portfolio A holds $100 worth of stock and sells a call option on the stock with a strike price of $112 with a settlement date of two years. The premium is use to buy a put option on the stock with a $112 strike price and a two-year settlement date. The series of transactions results in a $12 profit characterized as a long-term capital gain and taxed at a maximum rate of 15%.

Portfolio B invests $100 in a zero-coupon bond paying 6% interest a year. Imputed interest income of $12 is taxed at ordinary rate up to 35%.

This concept is presented in the example below: