Welcome to another episode of the Tax Tuesday show. Host Eliot Thomas, Esq., Manager of Tax Advisors at Anderson Business Advisors, welcomes Kurt Bergfjord, CPA for Entrepreneurial Business Services at Mazars, to help answer your questions. We send a big thank you to all our people online answering your questions today including Dutch, Sergei, Jared, Kurt, and many others.
On today’s episode, experienced tax advisor Kurt Bergford and Eliot discuss the three capital gain tax brackets, tax tips for real estate investors, S-Corps and LLCs, and financial planning strategies for families.
If you have a tax-related question for us, submit it to taxtuesday@andersonadvisors.
Highlights/Topics:
- Is it true that you don’t pay capital gains or dividend taxes if you make less than $40,000? If your total combined income is under 40K, there are no such taxes.
- I’ve been contributing to an HSA for several years. Can I withdraw funds from an HSA for prior medical expenses without a penalty? If so, how far can I go back? – as long as you have receipts, hold on to them and get the reimbursement in later years.
- Filing out state taxes. What are the pitfalls? Do we have to submit a whole state return if you have an investment in that state? – Your ‘resident state’ will tax your income from other states. You may have to file a non-resident income tax return in other states.
- Our LLCs, taxes of Partnership sold five long-term rental properties and it acquired one new rental property in a 1031, light, kind exchange. The original LLC still owns additional properties. How soon can we move the newly acquired property into a new LLC to be taxed as an S corporation? – Its not so much about the time frame but moving from one taxpayer to another ..it may disqualify your 1031
- We decided to be treated as an S corp. I’ve heard that we need to determine our W-2 salary based on our level of engagement each of the members have in the business. How can we determine our percentages? – To determine the percentage of ownership in an S Corporation, consider factors such as comparable technical knowledge, experience, and the average wage for the role.
- I’m thinking of transferring my primary residency into an LLC that I own and turning it into a rental. Can you explain how I should make the transfer so that I can get the 121 exclusion and have higher basis for the property in the LLC? – The 121 exclusion can be utilized by selling the primary residence to an LLC taxed as an S-corp, allowing for rental property depreciation.
- Can you speak about how options are taxed… would I pay capital gains on the spread or the total I received? Is it a capital loss? Is the cost basis lowered? Brokerage displays a lower cost-basis…This is difficult and complex…the credit spread occurs when you sell at one strike price, and buy another at different strike price…
- Do you recommend putting a flip into an LLC, If we buy and hold, later decide to sell, how does one change the LLCs, and how important to have the same address on the LLC… Living Trusts- should every property be included? Would you add homes if you’re only going to have them for 6 months. – Yes, if you’re flipping, don’t put it in your name. We want liability to stay in the LLC. You can use the same name but we don’t recommend it.
- Filing my 2022 as an S-Corp, my CPA recommended a profit-sharing plan, can I put it into a SEP-IRA, which do you recommend? – You need earned income from the business.
- I heard I can pay my kids without tax implications, what can I pay them? – Great strategy, put them to work, it’s a tax deduction to your business. They need to do actual work. In 2023 it should be lower than their standard deduction of $13,800.
- Rapid-fire chat questions answered at the end of the show
Resources:
Tax and Asset Protection Events
Anderson Business Advisors LinkedIn
Full Episode Transcript:
Eliot: Good afternoon. This is our May 9th, 2023 episode of Tax Tuesday. Today I’m hosting. My name is Eliot Thomas, Manager of the Tax Advisors. Joined by what I won’t call a guest, he’s been on here before. He’s one of our more experienced tax advisors, been with Anderson for some time now. [Kurt Bergfjord00:00:28].
Kurt: Good afternoon, everyone.
Eliot: We are, as our mission is, as Toby talks about bringing the tax knowledge to the masses— that’s the purpose of our Tax Tuesdays. It’s where you’re going to send questions in and we’re going to do our best to answer them. We pick a few of them. We got quite a broad spectrum of things that we’re covering today. Sometimes we get too much into maybe the real estate area or something like that. Because we do have a lot of clients asking questions about that. We certainly have some of that going on today, but we tried to expand the questions here into some other areas as well. We were able to do that because of the questions that you send in.
Speaking of which, as far as some of the rules when you bring the questions in, first of all, you can ask your questions through the Q&A section in Zoom, and we have a dedicated staff to help answer some of those questions. We got Dana, who is an EA as of yesterday. We have Dutch CPA, Jared, Ross, Sergei, Tanya, and Troy, all playing in the background answering your questions through our Q&A section. You can also email the questions to Tax Tuesday at andersonadvisors.com. If you need a detailed response, you will need to become a Platinum client or a tax client.
We try and make this fun, fast, and educational. Try and bring some education about tax to you all. That’s one of our goals and we just hope you enjoy the show. And Toby will be back, he’s just off today, so no worries there. We’ll have our boss and loved leader before long. Speaking of which, going to Toby’s website here for his YouTube channel. Here, you can go ahead and subscribe. He’s got all kinds of videos. I think we’re looking at 500 plus here. He’s also a best selling author of Infinity Investing, his big book. He covers a lot of that material in some of those videos as well as other tax items. By all means feel free to join up into his YouTube.
Also, here you can subscribe on YouTube at the aba.link/youtube for our replays, which we’ll have here. They will be on our website, replays of the show. I don’t think we take these down anytime soon. I think they’re up there permanently, actually, for better or worse. We can see questions already coming in and again we have the staff there. They’re going to get to your questions. Please be patient with them. They’re trying to get to them all and we do have typically a couple hundred questions that come in at this time.
On to the questions that were sent in today. All right, Kirk, first of all, is it true that you don’t pay capital gains or dividend taxes if you make less than $40,000?
Kurt: That’s actually a very common question that we get because it seems like the way it’s written, when you look on things, the internet is full of this, hey, if I make less than $40,000, are my capital gains subject to 0% tax? It’s kind of a little nuanced to answer. When we look at that $40,000, we want to look at what is that $40,000? It actually says, if you have taxable income of less than $40,000, your capital gains within that $40,000, because remember, capital gains income would be within your taxable income. For example, say you had $20,000 of wages and you had $20,000 of capital gain income. That $20,000 of wages would be subject to income taxes and that $20,000 of capital gain income because your total taxable income is below $40,000 will be subject to 0% tax.
However, a lot of times this gets misconstrued. Say you have again that same $20,000 of wage income, but then you have $100,000 capital gain on the sale of rental property. You just want to make sure that you’re thinking about what’s actually included in your taxable income. That’s going to include all things: interest, dividends, wage income, capital gains as I said before. Anything above that, say you had $100,000 capital gain in $20,000 of wages, the first $20,000 of your capital gain is going to be subject to that 0% capital gain bracket. But anything above that, you’re going to be jumping up to that next 15% capital gain bracket.
Remember, there’s three capital gain tax brackets. There’s 0, 15 and then 20. If you’re single, anything with your taxable income below $40,000 before $41,675 or $83,350, if you’re a married filing couple, will be subject to that 0% capital gain bracket. 15% will go anywhere between if you’re married filing joint, go between about that $83,000 number all the way up to $517,000. If you have capital gains within that bracket, those will be subject to 15% and then if you get over that level, you’re really doing well, kind of knocking out of the park, anything beyond that $517,000 at 200 number is going to be subject to that high 20% capital gain rate.
Eliot: Exactly, right. Yes, it’s possible you get that 0%, but as Kurt pointed out, there is always an asterisk next to that. So we have to do a little calculating. You might get some zero in there, maybe not if you make too much. But it certainly is a real thing. All right, great question.
Next, number two. “I’ve been contributing to an HSA for several years. Can I withdraw funds from an HSA for prior medical expenses without a penalty? If so, how far can I go back? Kurt got some medical expenses, I got an HSA. These expenses came from several years ago. What can I do?”
Kurt: Yeah. That’s a really good question, Eliot. And we actually get this a lot. Hey, I’ve been contributing for an HSA through my employer for several years now. It just dawned on me that I’ve been contributing to it, but I haven’t actually been getting reimbursed or taking a distribution for those qualified medical expenses that I’ve been incurring during those years. The IRS says there’s technically actually no limit to how far back you can go with those medical expenses to get reimbursement from your HSA. As long as you have good records—receipts, invoices for going to the doctor—things like that. Keep those, hold on to them. If you don’t want to reimburse yourself in any given year, you can just wait on that and get a reimbursement from your HSA in later years. That’s no problem.
Eliot: Very good. Great information there. Next question. “Filling out state taxes, what are the pitfalls? Do we have to submit a whole state return if you have an investment in that state?” Kurt we got our 1040, we’re always familiar with that. That’s a federal thing. But what about when we have this state objective coming up here for our taxes.
Kurt: Everyone’s familiar with the federal return, and also usually they’re resident state income tax returns. Usually your resident state, you’re always going to pay taxes on all your income. Say you live in one state, but you have rental properties in four or five different states, your resident state is always going to tax your income. Always.
However, say you live in one state and you have rental properties in two other states, what about those states? They might want to tax that income as well. It might be a situation where depending on how much income you have in any given state, you might have to file a non resident income tax return in various different states. Some states will say any gross income as a non resident if you’re earning any income within that state, okay, going to have to file a non resident income tax return in that state to report that income.
Other states will say all right, maybe if you have $1000 of taxable income in that state, maybe that’s kind of the threshold. You want to really be looking at the state rules specifically for each individual property or business. If you’re earning money in any given state, you want to look at those rules very closely.
Other types of state and local taxes that we want to be aware of. Certain states don’t necessarily have income taxes. An example of that would be Texas. But Texas does have a gross receipts tax. If you have gross receipts from a business that you’re operating in Texas, even if it actually produces no taxable profit after all your deductions, they’re looking at your gross receipts to levy some individual tax on those gross receipts.
Washington state is another example of things like a B&O tax. What is it? A business and operations tax in Washington state. Other kind of things related to that. California, another great example. The franchise tax [inaudible 00:09:54] essentially it’s more or less a tax for the right to do business in California. If you have income or businesses in various different states, I want to just keep a very clear guideline of what you’re doing in those states and what those states’ rules are related to the activities that you’re doing.
Eliot: Very good, yeah. Is it possible to talk state tax without California sneaking in there? Probably not. Those are some of your pitfalls. 50 different states, 50 different rules. That’s probably one of the biggest pitfalls, I would say. Also I was talking to Dutch who was helping us out here earlier today and he also mentioned something on some of these bigger investments you might get into, bigger partnerships perhaps, they also sometimes have a consolidated or condensed report—1065 report—that they’re going to throw out there. They actually do the withholding for you, which is a little bit different and unique. All that information will come through your K1 but we don’t run into that often. But he was just pointing that out as something that’s a little bit different in some of the states. Again, lots of states, lots of rules. Thank you, Kurt.
All right, let’s get on to the next one. “Are LLC taxed as a partnership, sold 5 long term rental properties and acquired 1 new rental property in a 1031 like an exchange. The original LLC still owns additional properties. So maybe we had 10 in there, we sold 5, we picked up 1, we got 6 potentially in there. Now we want to move the newly acquired,” That’s what we call the replacement property or 1031, “we want to move it into a new LLC to be taxed as an S corporation for asset protection.” Makes sense. “And because the new property will be a short term rental. All these reasons we want to get into an S corp is what we’re thinking. How soon can we do that, Kurt, without causing any problem with our 1031 exchange? Furthermore, the original LLC in the new LLC shares the same owners and ownership percentage. There’s no boot in the transfer.” What say you, Kurt?
Kurt: Yeah. The issue you’re going to come up with here is that you are going from a 1031 transaction from what was presumably a partnership originally into a corporation. That might be an issue for 1031 purposes. You’re not staying with the tenant of a 1031 exchange where you’re going from taxpayer to taxpayer. A situation where you’re moving properties from one LLC into a new LLC, which is taxes and S corp. That’s a different taxpayer. That’s going to potentially blow up your 1031 exchange. We’re going to be wanting to be very careful about doing that. Probably that’s not going to work too well.
But in terms of timeline, we really don’t have a timeline here because it’s not so much about the time. It’s about that you’re going from one taxpayer, which presumably is an LLC taxed as a partnership, to another taxpayer, which is not taxed as a partnership with the same partners and partnership percentages. But instead you’re going from a partnership to a corporation. Again, it’s probably going to disqualify your 1031. We want to be really careful about that.
There might be ways to work around, Eliot. Is that fair to do what the client is trying to accomplish here?
Eliot: I don’t know of any way really to work around that because as you point out, we have a taxpayer as a partnership, it really needs to receive that property. S corporation is a whole different EIN, a whole different tax report than that partnership. Now, we sometimes run across scenarios where we’re making reference to the facts that you give at the end here. Hey, we have one LLC with the same owners as another LLC, same percentage ownership, same people, etcetera. But that’s usually where you have one partnership and you want to move it into another partnership. That’s not what we’re doing here. We’re going from a partnership arrangement into a corporation. It’s an S corp. It’s still a corporation by at least some hybrid form. This is something I don’t think we could probably do anytime soon. Moving one property to the other.
Furthermore, we’re not going to recommend you put property into an S corporation as a general rule, because you never want to put appreciable assets into an S corporation for tax purposes. Now, here I know we’re doing it as a short term rental. That sounds more like an active business, so why not a corporation? Again, because it’s an appreciable asset and we get hit with taxes later on if we ever want to take it out or something like that. Which most often we get to the point where we do it at some point. But Kurt, there’s got to be something else that we can do to bridge that idea, okay, I keep it under the partnership and I’ll disregard the LLC, keep Anderson happy. But is there something to do with the activity of the short term rental, maybe with an S corporation. Do we have any avenues for me there, Kurt?
Kurt: Yeah. Actually, potentially because the short term rental most often is going to be considered an active trade or business. If you’re operating that directly out of that partnership, conducting that act, that short term business directly out of that partnership, most likely the partners of that partnership are going to be hit with self-employment tax. Might not want to do that.
However, there might be a workaround. Maybe we can set up a master lease to another S corp that you have set up. Maybe we set up an S corp where that partnership actually leases that 1031 property to this new S corp and then that S corp actually is able to conduct the active trader business. Again, the benefit there would be that the actual S corp is conducting the short term rental, doing the active trader business, cutting down on self-employment tax, taking advantage of some of the benefits of the S corp—accountable plan, maybe 288 reimbursements. That might be a good way to hedge some of that profit in that short term rental business.
Eliot: Excellent idea. We could still keep with our 1031, keep it on our partnership, and then through the master lease, still take advantage of some of that short term rental activity. As Kurt points out, active businesses now under an S corporation use those reimbursements, so on and so forth. Great plan. Hopefully that helps you out on that one.
All right, moving on. “I recently incorporated myself as a member of my husband’s LLC. We decided to be treated as an S corp. I’ve heard that we needed to determine our W2 salary based on our level of engagement each of the members have in the business. How can we determine our percentages? We run a residential business in California. He does the service part, I do the admin and advertising and bookkeeping.”
What do you got for us, Kurt?
Kurt: Yeah. So that’s a great question. The common question we get asked. I’ve heard I got an S corp set up, I’ve heard I need to take a wage out. What do I need to take that wage based out on? What are the requirements of that wage? So on and so forth. Yes, it’s true that if you have an S corp and you’re a shareholder of that S corp, you materially participate in that S corp, the S corp’s profitable at any given tax year and you want to take distributions out of that S corp, then yes.
Instead of letting all the income flow through that K1, that S corp tax return gives you at the end of the year, you’re going to have to take some of the income out as a W2. How much you have to take. The IRS says you got to take what it’s called a reasonable salary. What is reasonable? Reasonable could mean a lot of different things and it depends on some different factors. But what we like to say oftentimes is anywhere between about 30%–50% of your cut of the income from the S corp.
Again, if you know you’re working on the S corp, you’re participating, you want to take distributions out, it’s going to have to be taken out as a salary. In this example, it looks like husband and wife are kind of running the S corp. It looks like maybe one member is doing the bookkeeping there and then the husband is doing the service part. You’re going to want to take a look at, okay, we’re running this S corp in Southern California. What is a reasonable salary for if you’re doing bookkeeping 20, 25 hours a week, what is a reasonable salary for a bookkeeper with a comparable technical knowledge. A lot of the same experience that you have for that kind of role. Is that 20,000, is that 80,000? Depending on what you’re doing, but take a look at those. You can scope out and maybe go to indeed.com, maybe go to sites like Glassdoor, mid.com to get you an idea what is a reasonable salary for kind of those responsibilities that if you were going to go get a job from a third party, doing that same work, how much would you expect to be paid?
If that’s kind of in line with 30%–50%, great. If it’s drastically lower or drastically higher, you want to analyze it a little bit further. But if that amount is somewhere between that 30–50% range of a reasonable salary, great. Just kind of find what a good compensation level for you is and go through and run that through payroll and pay yourself that amount.
Eliot: Sounds good. S corporation, we always have that requirement for a reasonable wage if we take any distribution. As Kurt pointed out, you might want to look at some online sources to see what does the average person make doing what you’re doing, your experience, etcetera. All good suggestions for getting that way. As far as your percentage of ownership in the business that really is up to you to determine. A lot of our clients, if there’s couples going in, they do go 50-50. But that’s really up to you to determine the percentage of ownership in the S corporation.
All right, carrying on. “I’m thinking of transferring my primary residence into an LLC that I own and turning it into a rental. Can you explain how I should make the transfer so that I can get the 121 exclusion and have higher bases for the property in the LLC? I thought there were some exclusions in Section 121 that disallow such a transaction. I got my personal residence, Kurt. I’ve been living in it.We got the rules for 121 perhaps coming in here, but I want to turn it into a rental. Can I take advantage of 121 and still have it in an LLC as a rental, maybe with some stepped up basis or something like that?” What do you got for us?
Kurt: Yeah. This kind of poses a unique situation. Actually a lot of clients come to us with this similar situation. They’ve had a primary residence that maybe they bought 20-30 years ago at say $200,000. Maybe it’s gone up to $850,000 and with this last market run up, hey, we clearly meet the qualifications for 121 exclusion on a primary residence. We’ve used this primary residence as a primary residence for at least two of the last five years. We’ve owned it for at least two years. We want to capture up to that $500,000 exclusion that the IRS allows us to take advantage of with the sale of a primary residence.
However, we don’t just really want to sell the property. This market is great for renters, is great to rent this property out. We don’t want to just get rid of it. It would make a great rental property. We’re just trying to do something different in our life. Maybe we can combine these strategies. In that scenario, what we can do is actually set up an LLC taxed as an S corp. Remember, Eliot said this before, we almost never put appreciable real estate within an S corp. This might be the only exception that I know of that we get to disregard that rule. As a general rule, we never put appreciable real estate within an S corp. However, in this situation, because that LLC taxed as an S corp is a different taxpayer than us, we can actually sell our primary residence to that LLC taxed as an S corp. It’s a separate taxpayer so we can actually get the 121 exclusion, that up to $500,000 of capital gain exclusion from the sale of our primary residence.
Then what happens? We have an LLC that we own, we’re the shareholders of it, the LLC taxed as an S corp that we own, that owns this rental property. What did we buy the rental property for? We got to buy it for fair market value. Say that’s, in this kind of example, $700,000, $800,000 or something like that, we’ve almost excluded most of the game there, if not all of it. And then the rental property can be rented out to a third party tenant and we’re able to depreciate the entire purchase price that we paid—that the LLC paid—for that and have a bunch more depreciation. That’s really going to help mitigate some of the rental income and hopefully that will kind of produce almost a zero tax implication or taxable rental income on that LLC taxed as an S corp.
Eliot: Excellent. A little explanation on how we can take advantage of both the 121 and that stepped up basis, just a lot of good tax information there. Make sure we’re giving it to an S corporation. Just a reminder, we got to pay all that tax in the year that we sold it. But nonetheless you get a lot of tax benefit here, get to wipe out maybe up to half a million dollars in taxable gain there. Very good.
All right, the next slide just reminding us that we have our own Orlando Tax and Asset Protection Workshop coming up. It’s going to be May 18th to the 21st. As I said, in Orlando. I believe Kurt, you’re going to be there as well, yes?
Kurt: Yeah, yeah, I’m looking forward to it [inaudible 00:25:02] next week. Hopefully the weather is great in Orlando and if any of you guys on here will be there, I look forward to seeing you.
Eliot: Going to see Mickey Mouse and all that too?
Kurt: Oh, I can’t wait. My first time in Florida.
Eliot: There you go. You got to go.
Kurt: I got to see Mickey Mouse and an alligator. Those are my two goals.
Eliot: It’s his bucket list. You got it right here. All right, so as a reminder, 18th to the 21st, if you’re around, get down to Orlando. Beautiful area, Florida. And you’re going to hear from the gurus themselves—live—what’s going on. You’re going to have Kurt there to answer tax questions or just about anything else. He’s going to become an alligator expert for us and bring that all back to us here at Anderson.
Kurt: Next question. “Hey, I love the podcast. I was wondering if you could speak about how options are taxed. Specifically a credit spread where the profit I receive is only the spread between the leg I sold and the one I bought. Would I pay capital gains on the profit of the spread or the entire premium I received? Does that option I bought and subsequently expire worthless? Is that considered a capital loss? Additionally, when I sell a covered call, does it lower the cost basis of my stock? It seems that my brokerage displays a lower cost basis. If so, it would seem that the IRS double dips by charging capital gains on the options sold and considers my profit as qualified capital gains. Thank you for your clarity. Much appreciated.” That’s a mouthful. What do you say, Eliot?
Eliot: So yeah, we got a lot going on in this question. As I said earlier, Kurt and I get a handle an awful lot in the real estate realm as far as questions. Really like this one because we talk about trading structures and things like this, but this even takes us out further into the options world. What a difficult context here. If you’re just real estate, you may want to just hit the snooze button here for a second, but we’re going to go through the best we can here.
First of all, what is an option? Option is simply the right to buy or sell stock at a certain price, which we call the strike price price during a set period of time. That’s all an option is. Now here we’re looking at something a little bit different, the credit spread with these options. What that means is that it occurs when you sell an option at one strike price and then you go out and you buy another one at a different strike price. We call those legs.
Leg one, you go out and you sell an option, the right to sell or buy stock. And then leg two, later on you go and buy an identical option for the same stock, identical one at a different strike price. There’s some definitions going on there. Now, often if you look at this kind of commentary, they’ll talk about netting the two legs to get to what’s called a net credit.
From a tax perspective with the way the IRS looks at it, they look at the two legs independently. Whenever we talk about an asset—stock no different—you have what you paid for it. That’s our basis. We’re going to have that in leg one and you’re going to have a purchase price or basis for leg two as well, when we purchased the option. The first one when we sell the option, I sell an option to Kurt. Let’s say he pays me $5 for it, for the right to buy stock at $20. We call out the premium. He pays me $5 a premium. Right now, that’s my basis in that first leg.
Down the line, if I go out and I buy another option to fill out the credit spread here then I’m going to pay somebody for that option and whatever I pay for it is going to be my basis on that second leg. We know we got these two points, we call them legs, we know what they’re basis is. It’s just like if I go out and buy a house, I pay for something, whatever I paid for it, that’s my basis. No different here. But now we get to where we’re trying to calculate some gains and it gets a little fuzzy. Especially when we talk about the first leg. I think that’s probably the most difficult. We’re going to handle that first.
The reason it’s kind of challenging is because there’s different results that can occur—three different results. Again, Kurt paid me $5 a premium for the right, an option to do something at $20 with the stock. What if he doesn’t do anything? We call that letting the option expire. If he doesn’t do anything, Kurt paid me $5. I put it in my pocket. It’s my money. All I have to do is pay tax on that. Now it will be short term capital gains. This is a unique area in the code where it doesn’t matter how long I held that. Even if it was over a year, which typically you still go that long. But even if it was, it’s going to be short term capital gains regardless.That’s the first thing that can happen on that first leg as far as our taxes.
The second is, what if Kurt actually exercises the options? Although we have a divergent path, it depends on what type of option it was. We got two of those, one, a put option and a put option is the right for Kurt to sell stock at that stock price and my obligation to purchase at that strike price. He paid me $5. Strike price was 20. He’s saying I got to buy his stock at $20. Okay, what we do with that premium is even though I paid for it at 20, we usually say that’s the base. Because I got it for $5, we’re going to lower the base down to $15. Our new base, in this case, is $15. And then if I sell the stock above $15, while I have gain, capital gain, if it was over a year, then it’s long term. But what if I sell less than $15? Then if I sold it at 10:00, I’m going to have a $5 loss, capital loss. That’s all we do with the put.
But what if it was the other option where we have a call option. Again, a call option is the right for Kurt to buy stock, in my obligation to sell him the stock. It’s the exact opposite as they put in that sense. What we have here, if he exercises that, he’s forcing me to sell the shares at $20. But remember all the way in the back there, he gave me that $5 premium to buy the option. I’m going to take that $5 and add it to my proceeds from when I sold him the stock at $20. I got $25. Now is that a gain or loss? It depends. What did I originally buy the stock at? If I bought it at $22, sold at $25, got a $3 gain. But if I bought at $30 and I’m selling at $25 with that $5 premium, I got a loss of $5.
That’s how we determine that first leg of what’s going on our basis and whether we have a gain or how it’s handled. We have that second leg. Remember where I went out and I had to purchase an option. Before we get to that, we have the third possibility. That was where he exercised the stock. But another is where I go out and I just purchased an option to settle everything. We call it closing out. In that case, all I do, if I go out and buy a similar option, let’s say I paid $7 for it. Kurt originally paid me $5, I sold at $7 so I’m out $2. $2 loss, capital loss. Alternatively, if I bought at $3 and I originally got $5. More than $3-$5, I have a $2 gain. That was for the three options for our first leg of how we would determine the taxes.
Now moving over to the second leg, where I went out and bought an option on that second leg. Whenever I buy something, we talked about this earlier, that’s going to be my basis. Whatever I bought that option for, if I paid $10 for it, there’s my starting basis. Now, later on I’m going to sell that option. If I sold it for say $12, when I bought it at $10, sold at $12, $2 gain. If I sell for less than that, say $7, now I have a $3 loss.
But what if I don’t do anything? What if I let it expire? Remember, I originally paid $10 out there. I’m out of pocket $10 for this option. I don’t do anything. We consider this a sell at 0 and so I have a $10 loss. Getting back when we take that all into consideration that really is what we’re getting at in this question as far as the credit spread. If we look at the legs independently and determine their basis and the gains accordingly, if it expires worthless in the case of the second leg or something like that, if I had to pay out for it, then I have a loss.
If I’m selling an option and I just get the premium and it expires, then I have a gain. It’ll depend on which side we’re on. Also, when you’re talking about the covered call under this section, sometimes you see this lowered basis. We only see the lowered bases typically under the credit spread, as I said, when you get the put option where we take that premium of $5 and we reduce her basis for it. In the case of selling in a call, we’re actually going to add it to the amount we sold. What’s actually going on in your brokerage accounts here, I’m not sure why they’re changing. There may be some cost to purchasing these things going on or something like that, they’re changing it. To my knowledge, that’s the only time we’re going to have an impact on that base with the premium going on. We may not be able to exactly help you on why you’re seeing a difference, but it has probably something to do with some expenses and things like that.
We’re good to go on that one, Kurt?
Kurt: Yeah, excellent.
Eliot: Hey, everybody can wake up back up. We’re going to get back to something normal. This came in three parts, but they’re all relevant and good, so I wanted to hit all three of them. Number one, “Do you recommend putting a home that will be a flip into an LLC? Do I want some LLC protection for a flip? What are the tax pros and cons? Can you reuse that same LLC name?”
Good questions, number two. “If we buy and hold, decide six months later to sell, can we reuse an LLC name and is the physical address tied to that LLC? I know it will be deeded over to the LLC. In other words, things keep changing. How does one go about making the changes to the LLC’s and how important is it to have an address match the LLC? Wanting to make changes without huge costs being attached.” Good questions. Especially when you’re getting started and you’re trying to learn all these. Good questions.
Then finally living trust. “Do you recommend every new property being included in your living trust? With Anderson, can properties be added or taken out without a huge expense? Would you add homes if you’re only going to hold them for less than six months?” Any ideas on any of that Kurt?
Kurt: Yeah, so let’s start with that first one. “Do you recommend putting a home that will be a flip into an LLC? What are the tax pros, cons? Can you reuse that same LLC?” So yes, if you’re going to be flipping, we absolutely do not want you to be flipping out of your own individual name. If something goes bad with the flip and it’s in your own name, we want any kind of liability from that flip to stay with that flip in that LLC. We don’t want your own personal name being attached to it at all. Definitely, if you’re going to be flipping any kind of home, put that into an LLC.
I’m going to skip ahead just one second. “Can you reuse that same LLC name for a different flip?” I’m going to say you can, but we’re not going to recommend that. That’s the same kind of thing where, say you did one flip in one LLC, something went wrong with it and then you reuse that LLC to do a different flip. Say there’s new flips in that same LLC, some kind of issue comes along with that old flip, who’s going to get sued in that circumstance? That LLC which now has the new flip in it. You’re exposing the assets of that new flip in that old LLC to the liabilities of the old flip. We’re really going to recommend one LLC per flip.
Skipping back here. “What about the taxes?” That’s a very important point. We kind of touched on a liability issue, but what about the taxes? Usually, flipping is considered an active trader business. It’s not like holding passive rental real estate, it’s not like that. You’re conducting an active business and what is the issue with conducting an active trade or business? You might be subject to self-employment taxes on the profits that you make when you do those flips. So usually when we’re talking about structuring for flips, what we might do is set up some kind of corporation for you. Sometimes it’s going to be a C Corp, sometimes it’s going to be an S corp depending on your own unique situations. But usually corporations of some sort.
Then we’re going to have an LLC that is going to be disregarded for tax purposes to that corporation. What that’s going to do is any income from that individual flip held in that LLC instead of filing a tax return for that LLC, that income or loss from that flip is going to be reported on that corporation’s tax return. We’re going to avoid the self-employment tax no matter what kind of corporation it is, and we’ll have the additional benefits of certain kinds of corporations with the C. You’ll get Health Reimbursement Arrangements, medical expenses reimbursed. With a C organized, you’re going to be able to take advantage of that accountable plan. All your business expenses can be conveniently reimbursed to you, maybe take advantage of the 280A. Get some corporate meetings in there and really knock down that kind of extra profit that you have on the flip. From a tax point of view, that’s usually how we’re going to do that.
Number two here, “If we buy and hold and decide six months later to sell, can you reuse that LLC name and is the physical address tied to that LLC? I know it will be deeded over to the LLC. In other words, things keep changing. How does one go about making the changes to an LLC and how important is it to have an address match that LLC? Wanting to make changes without huge cost being attached.”
Very good question. So here, this is kind of a situation where we don’t have a flip. We have a buy and hold. Usually with buy and hold we’re going to put that buy and hold that rental property, its own LLC and that LLC is going to be owned by your Wyoming holding company. Say six months later, we decide to sell, can you reuse that LLC?”
Again, same kind of concept before. You technically can, but we’re not going to recommend it because who knows what happened during that six months. Maybe we rented to someone who had some kind of situation and there ends up being some liability coming back from that property. Do we want to be unnecessarily jeopardizing any new property that we place in that LLC by the activities that are long gone now? Let’s just clean the slate and get a new LLC in there and go from there.
I don’t really think the issue is with the physical address tied to that LLC. For example, often we’ll do 123 Main St. LLC. If you have a different property name, I don’t think that would be an issue. It’s more so the liability issue. You really don’t want to reuse those LLC’s that much. Again, having the addresses match, not a huge deal. We just don’t really want to keep those old LLCs around for asset protection.
And then three, the living trust. “Do you recommend every new property being included in your living trust? With Anderson, can properties be added and taken out without a large expense? Would you add homes you will only own for less than six months?” About that living trust, the way we structure the living trust we set up here, the attorney set up here, the living trust actually will never actually own any o f your rental properties, any of your businesses, any of your corporations per se. What will usually happen is your Wyoming holding company, that holds properties to your various LLCs that hold your rental properties, the ownership of your Wyoming holding company might be placed in your living trust. The Wyoming holding company owns everything, all the individual rentals. So when you get a new rental, you’re just adding on an LLC to that Wyoming holding company. The actual ownership of your Wyoming holding company is held within your living trust.
Similar to if you have a corporation like we’ve talked about before, you’re doing the flips with the LLCs. Each LLC per flip kind of thing. Again, none of those LLCs are actually going to be owned by your living trust. The corporate shares, the C Corp shares, the S corp shares, those might be owned by your living trust and that’s very easy to assign over.
Our attorneys can help if you have a Wyoming holding company if you have a Wyoming holding company that is owned by you individually, you have a C corp, the shares are owned by you individually, you set up a living trust. It’s usually a pretty easy transition. Get in touch with our Anderson attorneys and they’ll get the right amendments, the redactments, whatever needs to be done to move that ownership of your various businesses over to your living trust.
Eliot: Wonderful, all right. Then moving on to our next, the last question I think, the second to last. “If I’m filing my 2022 acts as an S corp, which retirement plan should I choose to put my money into my retirement? My CPA told me to put it into a profit sharing plan. We often talk about Solo 401K or something along those lines with the PSP account which I’m not familiar with, can I put it into a SEP IRA? What are the main differences between those two accounts and which one would you recommend to open?” Kurt, any ideas?
Kurt: What you really need to remember in this situation is to actually fund any type of retirement plan or contribute to any retirement plan, you’re going to need earned income from the business. Saying like you file an S corp in this situation, presumably as we talked about before, if you were profitable within that S corp, you had to pay yourself some sort of wage, so you’re going to have some amount of earned income. It kind of depends on how much that was, but you should be able to contribute either to a solo 401K or a SEP IRA.
A SEP IRA is going to be your own individual retirement account where a solo 401K is going to be sponsored by that S corp. If you actually need the S corp to sponsor that qualified retirement plan, that 401K. They’re kind of very similar in some ways, but there are some differences. Again, you’re going to need earned income to contribute to either one, but how much you can actually contribute to either one will depend on either one and kind of how that works.
I think the main idea here is that with the SEP, we’re talking about a profit sharing component. It still should be 25% of your compensation, but you’re going to need much higher wages to max out that SEP than you would if you had a solo 401K. If you were a solo 401K, you’re allowed to first use that employee deferral, that $20,500 can go for your employee deferral. I think in 2023, the difference should be $66,000 total that you can dump into that solo 401K. I think in 2022, $61,000 total. If the first $20,500 goes to the employee deferral, that leaves $40,500 that could go to that profit sharing component.
When you talk about how much of a wage we need to max out to get to that fully fund that retirement plan, you’re looking at about $162,000 in wages within your S corp to pay yourself a salary of about $162,000 so that you can fully fund that $40,500 employer portion profit sharing component. When we compare that to what it would be if it was a SEP, you’re going to need a lot higher wages. I think you’re going to about $245,000 of wages to max out the SEP. You might just want to keep that in mind that with the solo 401K, you’re actually able to pay yourself a little less, not even a little less, $80,000 less to actually max out that retirement plan. That’s going to be those wages that you pay yourself that are going to be subject to payroll taxes.
When you talk about advantages, disadvantages, the solo 401K is definitely going to save you some payroll taxes if your goal is to max out that retirement plan.
Eliot: Very good point. Excellent. Typically, I’m sorry if Kurt brought this up, your SEP usually is a more inexpensive plan so that might be a pro for the SEP IRA. But profit sharing plans may cost a little bit more but you need to pay yourself less in earned income. Also if it’s one that Anderson sets up, we have quite an open book for what you can invest in. Whereas the SEP IRA might have a more narrow investment world that you can get into, mainly real estate. Some SEP IRA plans may not allow for real estate investment, some might, but I know that our solo 401Ks are quite broad in what you can invest in.
Very good points. Thank you, Kurt. All right, moving on to, I think this is our last question. “I heard I can pay my kids to do some work for me without any tax implications. What’s the limit I can pay them and what are their requirements?” Kurt, help the parents out there, what do we got?
Kurt: Great strategy. Using your kids in your business, put them to work, teach them a little bit about earning a paycheck. Benefit for you, if you pay your kids in the course of your business, that’s going to be a deduction to tax, deduction to your business. Also that’s going to be income on them. The big thing about paying kids is you want to make sure that you’re not necessarily incurring a tax liability for them. Maybe a tax filing for them while getting the tax deduction.
We want to look at paying kids, again, they’re going to need to be doing something. They can’t just be sitting around, throw them on payroll. They really need to be doing something. It can be anything, doing yard work, taking out the trash, doing filing, maybe doing the internet market research. I know a lot of kids these days are pretty savvy with the internet. Maybe some of the actual business owners are not as savvy with the tech. Get them involved with that. Sure, have them start looking up properties. Maybe you’re into flipping and you’re looking for properties located. Get them on the internet, searching for properties for you, document their time, document their hours, treat them like any other employee that you have. Have them on time cards, filling out W2s, run payroll for them throughout the year. Issue them a W2.
Usually for kids, in 2023 we’re looking to pay them probably lower than the bare standard deduction. They’re going to have a gross income of say $13,800. What happens? That’s gross income that usually they would have to pay taxes on. But on their personal tax return they’re going to get a standard deduction. In 2023 the standard deduction for them is going to be about $13,800. They get to deduct that off the amount of wages they were paid and what’s their actual income tax liability? Big zero. It’s a win for you because you get the deduction and essentially they get tax free income. Maybe they consider using that earned income, that wage they get paid to fund a Roth IRA or something, get them going for college, giving them kind of set up for a first home or first business, whatever they want to do. It’s a kind of win-win for the family.
Eliot: Very good. That takes us to the end of our questions. Just a reminder, we can get on to Toby’s subscription for YouTube. Actually I don’t know what the address is, but nonetheless, just Google Toby Mathis on YouTube and you’ll find all kinds of videos out there. A lot of the topics that we talked about today, he’s no stranger to all types of tax questions. We look forward to having him back. But he is out, like I said, for this week. Again, just a reminder, when you send questions in for us to pick out, you can email us at taxtuesday@andersonadvisors.com and visit us at andersonadvisors.com or our main website page there.
Just a thanks again to our staff, Matthew, helping out with all the tech part of everything. We got Jennifer G and Alexis running this show, keeping us all in order and all those people pumping up the answers for all the questions. We got Dana, Dutch, Jared, Ross, Sarge,Tanya, Troy, excuse me if I missed anybody. Over 118 questions already answered. They’re bringing it. Thank you so much all for bringing the questions. We went all over the tax world today. We had capital gains, state taxes, S corporations, and of course we had the selling of options and things like that. We made it through that one, S corporations, reasonable wages, so on and so forth. It’s all because of you sending the questions. Thank you again. Please send them in and we look forward to seeing you in two weeks.
Kurt: Thanks everyone. Have a good day.
