Welcome to podcast episode #196 from Anderson Business Advisors, and this week’s edition of the Tax Tuesday show. Host Eliot Thomas, Esq., Manager of Tax Advisors at Anderson Business Advisors, welcomes Kurt Bergfjord, Esq.,Tax Consultant for ABA and 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 online today including Dana, Jared, Ross, Tanya, Troy, all from different departments, bookkeeping, tax advisors, the nonprofit department, attorneys, etc..
On today’s episode, Kurt and Eliot discuss the dos and don’ts of business partnerships and the best way to structure them, deducting medical expenses incurred outside the U.S. (along with what the IRS allows as an HSA reimbursement), and the usual array of questions around short-term and long-term rentals.
If you have a tax-related question for us, submit it to taxtuesday@andersonadvisors.
Highlights/Topics:
- “If bonus and accelerated depreciation were taken in 2022 via a cost seg on Schedule C, how many years does the IRS require that property to meet the active short-term rental criteria after the fact?” – There really is no requirement for you to keep it as a short-term rental from year to year to year. It’s a year-by-year, a tax year by tax year determination.
- “We have a two member LLC taxes a Sub S or just commonly known as an S-corporation. Two members or two shareholders. Each member/shareholder contributed a substantial amount of money of capital over four years. They’re putting a lot of money into this S-corporation, both of them, he or she. Can a member be bought out tax-free by the LLC by giving them a sell price in the form of capital distributions?” – It’s really no different than selling any stock, subtracting the shareholder basis…
- “If a medical procedure is performed in Mexico, can you use your health reimbursement account from your C-corporation?” – The actual medical expense certainly could be deductible anywhere. But when we talk about other types of auxiliary medical expenses like lodging and things like that, that is where we have to be a little bit more careful about what deductions we’re taking. No personal pleasure or vacation along with it.
- “Is there a list of IRS allowable health care expenses that can be reimbursed under Section 105 HRA (Health Reimbursement Arrangement), which is what we often set up with our C-corporations? There is a defined list of allowable reimbursements for HSA plans and FSA, cafeteria plans, but I don’t see an IRS specific list for 105 plans. Does the employer have some latitude as to what can be reimbursed?” – Publication 502 will give you a list of commonly deductible medical expenses.
- “I purchased my first short-term rental property last year. I’ve spent a year fixing it up, but it’s still not out as a rental. Can I write off my expenses from 2022 for a business that isn’t making revenue yet? If so, how? There’s no LLC started yet, so this would be on my personal taxes for now.” – Usually we look at if its available for rent, but the organizational costs may be deductible. You will have to wait until it is rentable/placed into service to get all the expenses deducted.
- “I share ownership of a single family rental property 50/50 with a relative. The other owner has not been involved. If I buy her out, step up in basis, or if she passes her ownership share to me by gift, then will I be responsible if I sell the property down the road for any depreciation that she may have claimed on her tax returns while she owned it?” – There will be depreciation recapture, 1250 or 1245, and some capital gains tax when the partner sells their interest if they realized profit. If gifted, the recipient has to worry about depreciation recap later on upon sale.
- “Me and my partner purchased, renovated, and set up a property in Houston for short-term rental. We have a 50/50 LLC.” “We’ve never partnered before. How do we separate the expenses and income? How do we file?” – All income and expenses are reported on one return, a multi member LLC is taxed as a partnership, each partner will get a K1 form detailing your portion – use that on your personal return.
- “I’m a 77-year-old newlywed.” Congratulations. “My husband has a trust for his family. Do I need one for my family, or is a will sufficient?” – A will can be contested and waste time and money in probate court. A living trust is much more clear and uncontestable.
- “I wanted to know if I can write off any stock trading education through my LLC if I pay myself a W-2, have 401(k) deductions taken out, and put into a self-directed Solo 401(k) plan. I am the only employee. I want to start learning about covered calls and so forth.” – maybe set up a partnership
- “When you pay your kids to work in your business, is this only allowed with a certain type of business structure, such as an LLC versus a partnership?” – No matter what structure you can always pay your kids to do actual work, but some structures are more efficient, like disregarded entities.
- Come out to our June Tax Events
Resources:
Tax and Asset Protection Events in June
Anderson Business Advisors LinkedIn
Full Episode Transcript:
Eliot: Good afternoon, and welcome to Tax Tuesday. This is our biweekly program here at Anderson to help bring tax knowledge to the masses, as Toby always says. I’m Eliot Thomas, manager of tax advisors here at Anderson.
Toby’s out today, and Jeff is out, but they’ll be back. I’m joined today by not really an unfamiliar face. He’s been here the last couple of times, Kurt Bergfjord CPA. Kurt, do you want to introduce yourself?
Kurt: Hi, everyone. My name is Kurt Bergfjord. I’m a tax advisor here at ABA. Just looking for a great show today to help bring in tax knowledge to the masses.
Eliot: There we go. I think he’s joining us from the West Coast. He goes a bit between there in Utah, so a bit of a traveler on our team. You may have seen him down at the Orlando event recently if you were down there. He got a chance to meet a lot of you, is my understanding. Got asked a couple of questions when you’re down there, did you Kurt?
Kurt: Yeah, plenty of very interesting questions down there in Orlando. That was a lot of fun. I can’t wait for the next one.
Eliot: The tax people tend to get swamped, and Kurt is certainly no different. Wonderful to have him here and be here with him. Anyway, getting on with the program here. Just a few reminders about some of our rules. You can ask questions live here through the Q&A section.
We have several of our colleagues, staff here today answering those questions. We have Dana, Jared, Ross, Tanya, Troy, all from different departments, bookkeeping, tax advisors, et cetera, from nonprofit department, attorneys. Sergei is going to be here in a little bit. We got a whole bunch of people back there to help out.
Of course, we have the live staff here, Patty helping out, and Kenny and company all helping us out here, and Matthew. We thank you for joining us today again. You can again put the questions to the Q&A section or in Zoom if you’re on the Zoom, as well as you can email questions to taxtuesday@andersonadvisors.com. That’s where we pick the questions from.
We try and level them out to what are the topics that most of you are asking about, as well as some that might be a little bit unique that we don’t get asked a whole lot about. We also understand that we have a lot of clients who are in real estate or stocks, so we try and put a fair share of those in there as well. We’ll get through the questions we have today, but feel free to submit them there through the email as well.
If you need a more detailed response, you will need to become a platinum or tax client. We certainly want to help out if we can on these. But remember, this is a free service, so sometimes only just generalities that we can give through this service. We want to help however we can, but sometimes we might need you to become a client to do so.
We try to make it fast and fun, not always fast, but fun and educational, just a way to give back to you clients and show our appreciation. Again, we do it every two weeks here. We are on episode number 196. Just getting into the questions, we’re going to try to hit straight to the questions.
First, just a reminder. We have a lot of YouTube activity from our partners. Toby being one of the founding partners, he’s got his YouTube channel here, and you can join up here. He’s got tons of video and content, always adding to it.
Something to keep in the back of your mind, Clint has one as well. You can subscribe on YouTube here for the latest at aba.link/youtube for replays. This will be up there as well for you platinum clients, a replay of this Tax Tuesday. Now, getting on to the questions. Are you ready to go, Kurt?
Kurt: I am, absolutely.
Eliot: All right. Let me read the first one off here for you. “If bonus and accelerated depreciation were taken in 2022 via a cost seg on Schedule C, how many years does the IRS require that property to meet the active short-term rental criteria after the fact?
In other words, since that depreciation was taken upfront in year one, is it reasonable to expect the IRS to require to maintain that status? But at some point, what if the real estate business needs to pivot to a long-term rental or something of that nature? What happens to that tax treatment in 2022?” Any idea there, Kurt, what we got going on?
Kurt: Yeah. It looks like you have a short-term rental filed on Schedule C. You took the depreciation in 2022. That’s all very fine, well and good. But then, maybe next year, when the intent changes, your business plans change. Anything can really change, and maybe there would be a need to pivot that short-term rental into a long-term rental.
There really is no requirement for you to keep it as a short-term rental from year to year to year. It’s a year by year, a tax year by tax year determination. If you meet the qualifications for that in 2022, that’s fine. You meet the qualifications for 2022. Whatever happens in 2023 really has no bearing on what happened in 2022.
Let’s say in 2023, you did pivot to a long-term rental, that house, that short-term rental would just pivot over to a long-term rental. You change where it gets reported instead of a Schedule C there. We’d probably be looking to have it reported where typical long-term rentals get reported. That’s Schedule E, and the adjusted basis for that property should carry over to Schedule E.
Really, not too much would change for 2022. But if you did change your intent later on later tax years 2023 or beyond, we would just report it a little differently on your tax return.
Eliot: Exactly right. I could go out there, buy a property towards the end of the year, maybe get that short-term rental activity, get that big depreciation in 2022. Kurt, you’re saying that, fine, we got that nice write off in the first year, even though we had a short period of time. The next year, we can go ahead and turn it into long-term, maybe it’s passive. We don’t maybe care as much because we got the heavy write-off in the first year with maybe bonus depreciation. Is that correct?
Kurt: That’s exactly what I’m saying. Take the write-off in year one, meet the requirements in year one, that’s 2022. If your intent changes, you want to acquire another short-term rental and do the same strategy in 2023, that original short-term rental in 2022 could just become a long-term rental and just less than the burdens of requiring to materially participate in that long-term rental in years going forward.
Eliot: Great. It is a strategy we’ve talked about a lot here at Anderson. A wonderful question. Thank you, Kurt. Get on to the next one.
“We have a two member LLC taxes a Sub S or just commonly known as an S-corporation. Two members or two shareholders. Each member/shareholder contributed a substantial amount of money of capital over four years. They’re putting a lot of money into this S-corporation, both of them, he or she. Can a member be bought out tax-free by the LLC by giving them a sell price in the form of capital distributions?” What say you, Kurt?
Kurt: When we’re talking about actually buying the S-corp buying out that member’s ownership interest in that LLC, we’ll probably be looking something at a stock redemption. When you redeem stock as a shareholder, an S-corp, whatever price you get paid to redeem that stock is going to be your proceeds from that redemption. It would determine what your basis is in those shares to determine if you had a capital gain or not.
If the LLC were able to buy out that interest at something similar to the value that you actually put in, it said he had made capital contributions over four years, so it’s very possible that you have a pretty substantial tax basis in your shares. It’s very possible it could be tax-free. But keep in mind, the redemption of those stocks should be close to fair market value. It depends on the assets that we contributed, what the assets have done within that S-corp thus far, but it’s certainly possible that it could be bought out tax-free.
Eliot: Very good, excellent. It’s really no different than just selling any stock. In a sense, you’re going to get a sales price or the redemption price back. We subtract out that basis that we have, which in this case is your shareholder basis in that stock. That’s how we determine if there is any gain.
As Kurt pointed out, if that amount happens to be equal to whatever our basis was or shareholder basis, then it’s possible that there’d be little or no tax on it, certainly. All right, excellent.
Next question. “If a medical procedure is performed in Mexico, can you use your health reimbursement account from your C-corporation?”
Kurt: Yes. Again, I’m not unaware of any specific rule or regulation prohibiting a medical procedure being performed in another country. You have to keep in mind, though, that if you’re going to a foreign country, it shouldn’t be that you’re necessarily going on a nice vacation to Mexico, and you just happen to be getting a medical expense done there.
The actual medical expense certainly could be deductible anywhere. But when we talk about other types of auxiliary medical expenses like lodging and things like that, that is where we have to be a little bit more careful about what deductions we’re taking.
I think the IRS says there should be no significant element of personal pleasure, recreation, or vacation, in the travel for getting those medical expenses. You just want to be a little careful with that. You certainly can have a medical procedure done in a foreign country and use your health reimbursement account to have that reimbursed and deductible by the corporation.
Eliot: Perfect. Just before we get excited about maybe having that trip so that we could have, as Kurt pointed out, maybe even a hotel portion being paid by that, it is limited to $50 a night. There are other stipulations and things like that. We probably don’t want to get that five -star hotel just yet.
If we’re doing something like that, we want to keep it related to that medical procedure, and certainly can’t be cosmetic as its sole purpose. It really has to be for the prevention or significant medical problems, probably definitely done by a licensed medical professional.
That is a big area of the things that we talked about, that medical reimbursement plan. I had a few questions that came in during the last two weeks for Tax Tuesday for that. We actually have another question along the lines of our health plans and things like that.
“Is there a list of IRS allowable health care expenses that can be reimbursed under Section 105 HRA (Health Reimbursement Arrangement), which is what we often set up with our C-corporations? There is a defined list of allowable reimbursements for HSA plans and FSA, cafeteria plans, but I don’t see an IRS specific list for 105 plans. Does the employer have some latitude as to what can be reimbursed?” Where do we go to look for? What can we do on our 105 plan?
Kurt: When we talked about what’s allowable, certainly things that would be allowable under HSA and FSA plans are what we’re going to first look at. We’re also going to look at what else might be deductible if we hadn’t got a reimbursement. We just paid out of pocket and try to take that medical expense on our Schedule A, on our personal tax return.
In that case, the IRS has a great publication, it’s publication 502. All you got to do is google that, publication 502, and it will give you a list of commonly deductible medical expenses. They go through almost any medical situation that you might have. That’s a really handy publication to keep in your quiver. If you have a question on whether it’s something deductible or not, head right there.
For us, when we talk about what is deductible under Section 105 plan, that is usually what I would look towards to see, is this specific medical expense deductible first? If it’s deductible there, very good chance that it would be able to be reimbursed under the 105 plan.
Eliot: Very good. Just a rule of thumb, some of us will tell the clients, a medical professional, if it’s something that they have prescribed or treatment that they have requested that you get for some, again, prevention or curing of some medical condition, more than likely you’re going to fall in there because even the 502, that publication is expansive. A list of different things that can be done. It’s certainly not exclusive.
There are a lot of other things out there (I’m sure) that aren’t in it, but it is certainly a great resource to look at. It’s one that we look at often to try and guide clients. Excellent job. All right, next.
“I purchased my first short-term rental property last year. I’ve spent a year fixing it up, but it’s still not out as a rental. Can I write off my expenses from 2022 for a business that isn’t making revenue yet? If so, how? There’s no LLC started yet, so this would be on my personal taxes for now.”
Kurt, I got a property that I’m setting up for rental. I’m not done getting it placed into service. I’m still working on it. What can I do for expenses if anything?
Kurt: It looks like you have a rental property, fixing it up not quite in business yet. Usually, we’d be looking at, is it available for rent? If it’s not available for rent, usually, we might be able to take simply the organizational costs associated with getting that business up and running. Probably not the startup costs.
Most likely, when we talk about the short-term rental, what really is going to be valuable to you is that depreciation component. Because the rental was not operational, was not available for rent by the end of the tax year, usually we’re going to be limited to being able to start depreciating that short-term rental.
There might be some availability to write off some of those expenses, maybe just those organizational costs. But commonly, a lot of those expenses will be started to be able to be deducted in the year you actually place that short-term rental in operation, which would be 2023.
Eliot: Very good. That is an oft asked question of us. Hey, I don’t have any revenue yet. Often, people associate the production of revenue with being maybe the start of some tax event. The only thing that starts is that you will have to pay taxes if you do have net revenue, but that’s not what we look to, to whether or not we have to do a return, if a loss indeed would come up, or if it’s placed in a service. Those are all different things that we would look at.
As Kurt pointed out, with a rental, be it short-term or long-term, we don’t do anything with it until it’s actually been placed into service. That’s when we’ll start to have that activity showing up. Moving on.
Kurt: “I share ownership of a single family rental property 50/50 with a relative. The other owner has not been involved. If I buy her out, step up in basis, or if she passes her ownership share to me by gift, then will I be responsible if I sell the property down the road for any depreciation that she may have claimed on her tax returns while she owned it?” That is a good question.
Eliot: Yeah, it’s a wonderful question. We do get this from time to time. It does depend on which option we’re going for here. If one sells the interest and the other purchases, as Kurt pointed out, we’re going to have a taxable transaction there. You mentioned stepped up basis going on there.
The key to the depreciation here is that, if Kurt and I had a rental, and I bought out his share, I’m simply going to take over the property, but he probably sold his interest at a gain of some sort. If you recognize his gain, then he is going to have depreciation recapture at that point, depending on the amount of gain.
The way depreciation recapture happens is, if you have gain, the first top portion of that capital gain will be subject to depreciation recapture, 1250 typically, or it could be 1245 if we’ve done a cost seg. Up to that amount of depreciation taken, that first top of the initial capital gains will be taxed at a higher rate, and then the rest would be just through capital gains, maybe 15%, possibly zero, or 20% more commonly, something along those lines.
There will be depreciation recapture for the partner, in this case, that sold their interest if there was a gain. If it was sold right at the amount of their interest in the partnership, then there wouldn’t be any gain.
It’s very similar to what Kurt was talking about earlier in the earlier question of the S-corporation. It is possible to have an amount that is equal to the partnership interests outside the basis, we call it, and therefore there would be no gain. If there’s no gain, there’s no depreciation recapture, and the purchaser would not have to worry about that portion.
On the other hand, we talked about, what if we gifted something here? If Kurt gifted his interest to me, then I as a recipient of that would have to worry about depreciation recapture later on if I sold it. To our questioner here, in the case of buyout, no depreciation recapture for the person buying. But in the case of donation or gifting to the buyer we’ll say, then there is depreciation recapture later on upon the sale of that. An interesting question there.
Just a reminder. Clint Coons also has his tax and asset protection workshop. You’ll often see Toby in there as well. This was the event that they did down recently that we’re talking about in Florida not too terribly long ago that Kurt was at. It looks like we have a one day event coming up on June 15th. It’s free online for the online portion, and then another one on June 24, two weeks later. Be sure to get there if you can.
Even if you’ve been to them before, it doesn’t hurt to get back in there. A lot to learn about it. They always try to update these things as well, maybe with some new data, if anything else has come up. Always good to get in there and hear it again sometimes.
Also, just reminding, we also have that Structure Implementation series out there that you can check on our website if you are platinum clients, that is. That’s another great way to learn more.
Here, our bread and butter, tax and asset workshop protection, Clint gets into all that asset protection. It’s very important to learn about. Toby comes in and talks about the tax side of things. It’s really a wonderful event. Hopefully you can make those events on the 15th again and on the 24th.
Going on with the questions. “Me and my partner purchased, renovated, and set up a property in Houston for short-term rental. We have a 50/50 LLC.” Looking at a partnership, it looks like. “We’ve never partnered before. How do we separate the expenses and income? How do we file?”
Kurt, I just got in this venture with somebody, maybe with you. What’s going on? How does this handle housing income expenses? How do they all get handled?
Kurt: When we talked about separating the expenses and income with that LLC, all the income and expenses are going to be recorded on that one LLC. Because that LLC is a multi member, and presumably, when you say you’re a partner, that’s a business associate or something like that, any multi member LLC is actually going to be taxed as a partnership.
When we talk about how to actually separate that out, the LLC in question will report its income from the short-term rental. All the expenses on that short-term rental right on that partnership, tax return form 1065, and along with that filing, the 1065 will issue each partner, you and your partner their K-1, which will detail your 50% of the income and your 50% of the expenses.
Similar to your partner. They’ll get 50% of the income and 50% of the expenses on that form K-1, and then you’ll use that form K-1 when you go to prepare your personal tax return. You’ll incorporate that K-1 into your personal tax filing so that you’re in effect getting 50% of the expenses and 50% of the income.
There is really no separation on the LLC level. It will all go on that one 1065 filing, which in the process of doing that filing will issue that K-1, and then you’ll use that to prepare your personal tax return.
Eliot: Just a little bit of a curveball. Sometimes, when we talk about a partnership like this, Kurt, probably an unfair question I’m just throwing out here, but is there ever a time when maybe in a partnership, we might be able to allocate differently for some reason or another? Have you ever run into that at all? We talk about sometimes.
Kurt: Yeah. Sometimes, there might be a reason to specially allocate income or expenses differently among the partners. It depends on who’s doing what. Maybe one partner is just putting in the capital, and maybe one partner is putting in the sweat equity.
You certainly can make an agreement with the LLC, and lay that out within the LLC agreement to apply the tax attributes differently depending on how the partnership is made up and who contributed capital, who contributed services, and things like that, that might change the nature of how much income, expense, or which specific income or expense items get allocated to each individual partner.
When you’re going to do that, make sure that you have that agreement in writing. The key there is that it makes economic sense. Just because Eliot put in all the money, and I put in all the sweat equity, it does not mean that I’m entitled to certain deductions, and he’s entitled to certain incomes. It’s got to really make economic sense when you look at it from a holistic point of view. That’s just one thing to keep in mind.
Eliot: Excellent. Certainly, it’s something that can be done. We do get asked that a lot because a lot of the great examples that Kurt just gave, maybe someone put the house in and the other person did all the work. Maybe they want to give all the depreciation to the one who put the house in. That can be done.
It’s something that, again, as Kurt cautioned, you don’t want to just go out there and do. You want to have language in there about this substantial economic purpose or reason that you’re doing it that it makes economic sense, et cetera. There are some particularities to it. While generally, we like to see if it’s 50/50, we want to see things split. That would normally be the case amongst that profits percentage.
There are avenues for that changing around, but it’s not something to be taken lightly. The IRS sees it. They’re going to want to come and see why we’re doing that. You want to have that, as Kurt pointed out again, the reasoning, the backup, and how it was being treated on that return.
Excellent. Moving on to the next question. “I’m a 77-year-old newlywed.” Congratulations. “My husband has a trust for his family. Do I need one for my family, or is a will sufficient?” Have you ever heard anything about maybe how the partners think about wills versus trusts? Anything like that ever ran across your desk there, Kurt?
Kurt: Yeah. If you have a will, that’s always a good starting point. However, a will can be contested. Often, when we talk about what is good, better, best, having a living trust by placing all your assets within the living trust. It’s very clear when you ultimately pass, where you’d like your assets to go. That’s very clearly laid out.
That usually is a better bet. The reason we usually like that over a will would be that a will is going to be something that can be contested. It has to go through the probate process. A living trust, you’re actually just strictly directing where those assets go. It saves a lot of money on the probate costs.
Before I came to Anderson, I had a situation where a client didn’t have a will or a living trust. There was some significant amount of assets. Some states actually—I think we were in Connecticut at the time—charge to administer the probate estate, actually a percentage of assets.
This client had a large, large amount of assets to go through probate, and the probate was incredibly expensive for that client. Not only professional fees to administer the entire probate, but also on the court level to administer the probate through the court was just an unnecessary expense that could easily be avoided if the client had a living trust. Always a pretty good idea for something like that.
Eliot: Excellent points. Yes, Kurt’s exactly right. I used to work for a law firm that did that quite a bit. It had a lot of will activity coming through. Trust just really wasn’t used a whole lot at that time. I’m a little bit older, and I was quite a bit younger when I was working at that particular firm. It is an added expense, just as Kurt pointed out, one that you can avoid.
It certainly cuts down on the red tape. I’m not going through probate or at least limiting anything that would go through probate. It doesn’t mean that there’s no “red tape” with a living trust. There’s a lot that has to be handled sometimes with that as well. I think we can all promise you that it’s certainly a lot easier through a living trust.
Unfortunately, when those things are being used, it’s usually a tough time to begin with. You probably want to make it as easy on your heirs or beneficiaries as possible. We highly recommend using that living trust. Always to just set some things straight and not leave it up to the courts. Maybe a lot cheaper for your estate overall than going the will option.
The living trust is something revocable living trust gets it set up. We do those. Certainly, we have Sergei who’s I think on here answering some questions. Maybe he might be in yet. He handles a lot of them. Maybe he’s not. He’s probably doing one right now.
Anyway, very good. Thank you, Kurt. Getting on to the next question. “I wanted to know if I can write off any stock trading education through my LLC if I pay myself a W-2, have 401(k) deductions taken out, and put into a self-directed Solo 401(k) plan. I am the only employee. I want to start learning about covered calls and so forth.”
Maybe we have some education with trading. I guess it doesn’t really even matter what the education is. How do we work that with an LLC, Kurt?
Kurt: In this circumstance, it might be a good idea to start looking at what we often set up for people looking to get into the market, what’s called a trading structure, an LLC taxed as a partnership, where you are one of the partners in that LLC. You also have maybe your corporation partner with you in that LLC.
Maybe you have a 90% ownership, maybe the corporation has a 10% ownership, and the corporation is actually serving as the manager of that LLC. The LLC actually holds those brokerage assets. Actually, it does that trading activity.
What that’s going to do is allow that corporation because a corporation is going to have a lot more flexibility to write off things like education and other business expenses as a manager of that trading LLC, compared to if you just have that LLC, and it’s simply disregarded to you.
Again, if you have that C-corp, as a partner within that LLC, partnership structure, not only can you pay yourself a W-2 wage, you can set up a Solo 401(k) through that corporation, maybe make some contribution to that Solo 401(k). All things that really open up the option to do a lot more interesting things by changing the LLC to just being disregarded to you, having you as the only member to adding your corporation as a member in that LLC, running that payroll, those education, those 401(k) contributions through the corporation itself, and just having that corporation be the manager there.
Eliot: That’s right. It’s a very popular structure that we have, the trading partnership for our clients who do a lot of trading. It’s not for everybody. It does matter a little bit about what you have going on in your particular situation. You certainly want to talk to our senior strategists and things like that to maybe get properly set up for something like that.
Just as Kurt pointed out, many times, one might incur some of these education or training expenses. The typical general rule is you cannot deduct those. This is for a new line of business. You can’t deduct it on your 1040 as a Schedule C sole proprietor. You couldn’t do it through a partnership.
Often, what we will do, and really you’re not supposed to do through an S-corporation either, C-corporation is often the only way you can deduct it. As Kurt pointed out, we set up a partnership, maybe have the trading activity in that partnership. The C-corporation is just one of the partners, and you’re the other one.
Maybe you have 90%, C-corp has 10%. That allows you to get the education training taken care of through the C-corporation, in which case it will be deducted there, where it’s allowed to be deducted because you can train your employees. You’re allowed to do so in a C-corporation, whereas you couldn’t if you didn’t have that.
Also, just from the trading activity itself, if you had $100 of income from trading, and you didn’t have that, all $100 is going to come to your 1040 on your personal return, all the tax depending on what your tax bracket is at the capital gains rates. But if we have that $100 being earned in our trading partnership, automatically $10 of that or 10% will go to the C-corp, which is a 10% partner.
Right there, we’ve saved 10% or $10 in our example from being taxed on your 1040. That $10 may not sound like a lot. But if that trading gain becomes $100,000 or more, that can be a significant amount of money that gets moved into the C-corporation and kept off your 1040 to be taxed.
Once that money is in the C-corporation, as Kurt pointed out, there are so many deductions we have on that C-corporation. Medical reimbursement plans, we had a couple of questions today about those. You can get some of your medical premium reimbursed or things like that. Trips to Mexico if need be for medical treatment.
Co-pays. You go to the doctor. You have to pay a copay to see the doctor. He or she writes your prescription. You run over to the pharmacy, you have to pay co-pay there. You can get all that reimbursed to the C-corp. All that money that was going to be taxed originally on your personal return, now it’s in the C-corporation.
You have an accountable plan, which can give you a home office. If you have a home office that you’re operating the C-corp for, it can be reimbursed for the costs related to that based again on the percentage of the space that that office is taking up in the house. Some of your personal expenses actually can be reimbursed through the corporation tax-free to you.
All these reimbursements are tax-free. The medical reimbursement, accountable plan reimbursements, all money coming in your pocket, tax-free, and their deductions at the same time to the corporation.
Corporation also was required to have corporate meetings. Under Section 280A, you can have some of those in your house as well. We want to make sure we abide by all the rules and make sure we’re having actual meetings, et cetera, but it can pay for that. All great ways to get that money out of the corporation back in your pocket tax-free, deduction to the corporation at the same time, again all from money that would have otherwise been on your 1040, if you didn’t have that structure. If there’s not enough money in the corporation, the corporation can be paid for its services that it’s providing.
In a partnership, we have a very special, unique item called a guaranteed payment, which is just paying the corporation basically for its activities. It’s a flat fee. It can pay that in or get more money into our C-corporation, and help cover those reimbursements that Kurt and I were just talking about.
Again, medical reimbursement, accountable plan reimbursements for maybe an administrative office, mileage, or something like that, and then again, corporate meetings as well. A really powerful plan. You run across a lot of these, Kurt?
Kurt: Yeah. Actually, it’s probably about every week that we’re having a discussion with a new client who’s just either really doing well in the market. They’ve already been investing for a long time, and they’re looking for some benefits to take the edge off some of that investment income.
Or they’re just getting into trading, doing covered calls, or any portfolio investing. They’re just looking for the right structure up front so that they never do it the wrong way, and then get their taxes filed and realize how much tax they’re actually paying on that investment income. You see it quite often.
Eliot: We just saw on one of our earlier slides that we have Clint and Toby coming up with that tax and asset protection, where we learn a lot about these tax tactics, structures, and things like that. That’s the trading. Kurt, what if we also have some rentals out there? We’ve seen questions. We know we have a lot of clients with rental properties and all that. Can you use the same C-corporation?
Kurt: Absolutely. There could be numerous ways to use a C-corporation. You can use it in the trading structure to manage your stock portfolio in this trading structure we’re just talking about. That same C-corp could also be used to manage your rental properties. Maybe it’s a short-term rental that you have right in that C-corp. Maybe you’re just using that C-corp to manage your long-term rental properties.
There are really a lot of things you could do with it. I have clients that are flipping out of their C corps. If there are extra deductions that you can capture in that C-corp, and there are multiple streams of income to that C-corp, there’s really a lot you can do with it to maximize the tax benefits of having those corporations. They can be tremendously beneficial in a lot of different ways.
Eliot: Very good point. Also, being a C-corp, correct me if I’m wrong, Kurt, but it’s taxed at a flat 21%. If we get any money in there off of our 1040 and we were at the 37% tax bracket, at least we’re able to save a little bit there as well. That could help out in the bottom line as well.
Kurt: Absolutely. That low flat 21% compared to someone who’s not only in the 37% tax bracket, maybe some of that income depending on how it’s earned. For example, they’re doing flips. That might also be subject to self-employment tax. Not only you’re saving 37% or the difference between 21% and 37%, but also potentially the self-employment tax and potentially a lower state tax rate. It can be tremendously beneficial.
Eliot: Excellent. As you can see, a lot of use with these. We can build these structures. We got, like I said, our senior strategist always out there tinkering and putting these things together. Toby and Clint are always out there, and things like the tax and asset protection class helping them get that information out to you. Again, feel free to join that 15th and the 24th.
Next, I think this is our last question. “When you pay your kids to work in your business, is this only allowed with a certain type of business structure, such as an LLC versus a partnership? A lot to unpack there. What do we get going on here, Kurt?
Kurt: Yeah, it is a lot to unpack. The first thing to remember is, no matter your business structure, you can always pay your kids to work in your business, as long as they’re doing things that you would pay regular employees to do. It can be a great way to shift income off your tax return or your taxes, and shift that income to their tax bracket, potentially have them pay little to no income tax on their side.
You can always pay your kids no matter your business structure. However, there can be ways to have your business structure be more efficient when it comes to paying your kids. It depends on what your structure is, but oftentimes, if we were to use simply a disregarded entity that was owned by husband and wife to pay the kids, depending on how much we pay them, if we pay them just up to the standard deduction which I think is $13,950 in 2023, if I’m not mistaken, if you pay them just up to that point, not only are they going to get the benefits of that standard deduction. Essentially, they pay no federal income tax. If you pay them through a disregarded entity, also, there might not be any payroll taxes associated with those wages.
For example, if you already have a corporation like we’ve been talking about, you can potentially, instead of paying them directly out of the corporation, you can set up a disregarded entity, maybe have the corporation have a contract between the disregarded entity and the corporation for those services. Pay the kids directly out of the disregarded entity. Have them on payroll through just running payroll, just like you would with any other employee, and then there would be no payroll taxes. That’s FICA, FUTA. Potentially, any state payroll taxes that are associated with that would not be subject to it if you did that particular way and pay them through the disregarded entity.
The corporation just pays a contracted fee to the disregarded entity to cover those costs. You’ve essentially paid your kids without incurring payroll taxes. As long as you don’t pay them above the standard deduction, you’ve also made those wages not subject to federal income taxes as well.
You might have to worry about a little bit of state income taxes, depending on what state you live in. But overall, especially with clients who are in the higher tax brackets—25, 32, 37—anything like that, it can be tremendously beneficial to just shift income over to your kids. Maybe get them started on a Roth IRA and things like that, so when they have that money, they can start investing that, throw it in the Roth IRA or something like that. Maybe they’ll never actually have to pay any income on those wages ever. It can be a tremendously beneficial way to shift income to your heirs.
Eliot: Very good. Even if we don’t want to go through the extra effort of setting up that separate LLC, as Kurt pointed out, you can pay them directly from your operating business. If it’s a corporation or what have you, that’s certainly not a problem.
One thing to take away though, if we are trying to get the savings for younger children 17 or under, if we’re saving on self-employment tax, they have to be paid as W-2. They can’t be 1099. They must be W-2 employees of that entity. That does have to, again, be maybe a sole proprietorship owned by one of the parents, or a partnership owned by both the parents, something of that nature. We could not do that.
Again, get that employment tax savings if we were paying them out of an S-corp or a C-corporation, but still you can get benefit in that. If we pay them under that amount that Kurt was talking about, the standard deduction approximately $13,950 or thereabouts in that neighborhood this year for 2023, then they don’t pay any federal income tax. Still a tax savings, but they would have to pay the employment taxes.
If they’re being paid out with a C-corporation, other thoughts because it starts to get a little bit more complicated when we throw in these different scenarios, but maybe mom and dad already have that set up. Like we talked about in one of these previous C-corps that we’ve talked about in the previous questions, maybe we have a Solo 401(k) setup. That should only have mom and dad as employees of the sponsoring entity. We don’t want to bring the kids on as employees because that could change up what we’re allowed to do with our Solo 401(k). We might have to get a standard 401(k) as opposed to a Solo.
Maybe there, if you want to pay them as independent contractors, if at all possible, there is a distinction between when we can call someone an independent contractor versus an employee, I believe, Kurt. I know we’ve talked about that in previous Tax Tuesday’s before. Any idea when you’re an independent contractor versus a W-2?
Kurt: Independent contractors really are going to function independently of the employer. It’s certainly possible that your kids could be independent of you or your business. Just set them up. Give them a little bit more discretion on what their tasks are. Give them a little bit more flexibility.
Don’t treat them like the rest of your employees. Just make sure you issue that 1099 at the end of the year instead of doing the formal payroll. You just claim them as independent contractors.
Eliot: Exactly right. In a lot of different tests out there, you’ll see the federal test for independent contractor versus employee. There are maybe 17 different items on there. I think all of them state or federal tests for this, one of the big criteria is the control. How much control do you exhibit over this individual, be it family or not? Are you telling them when to do it, how to do it, where to do it, so on and so forth?
Are they independent? The more independence, the more they look like an independent contractor, as the name suggests. Keep that in the back of your mind, especially when we’re talking about employing the kids. Just be aware of these things that while yes, we can do these things, set up these structures, they can impact other things such as a Solo 401(k) example of having our kids on there. We may not have that assessable to us, the Solo 401(k) if we brought children on as employees. We might want to think of different methods of paying them.
A lot of benefits to it, certainly, as Kurt went over, they can sponsor their own Roth plans and things like that. Start them at an early age. Maybe put it away for college later on or something like that. What are you going to pay them for? They can do any number of things. Social media is always a popular one. I know my sister’s kids know all about that stuff. I know nothing.
If I have or had something, I can employ them to try and help me out, marketing or something like that, just things. Great question. I love these questions. It shows that you’re getting out there thinking about these different things. Very wonderful.
I think that was it for our questions for today. Just as a reminder, please check out the YouTube sites, Toby’s and or Clint’s. I think Carl has one as well. Coffee with Carl, I believe, is on there as well. A lot of Anderson YouTube stuff going on.
Toby’s here, as you can see. Feel free to click in there. He puts tons of videos up there. His facial expressions on a lot of them. Moving on, of course, as we talked about the tax and asset protection workshop, again, coming up here, it’s online, free virtual event on the 15th of June, and again on June 24th. Really great event. You’re going to learn a lot about asset protection.
Again, Toby is going to throw in there the tax side and where the two meet. No better presenters of this material out there than Clint, Toby, Michael Bowman, and our partners out there doing this. Again, it’s just a way to give out to the clients some more free information. If you’ve already been there, I encourage you to go again just to learn more. Some of the stuff you learn by repetition, so feel free to get in there.
Again, we have other training items like Structure Implementation Workshop or Structure Implementation series. If you’re a platinum client, you can find out more, get in there, and learn about how it all runs at a more in depth level and things like that, free to platinum clients.
I think that’s all we have for today, Kurt. Just as a reminder, if you have questions for the next Tax Tuesday coming up in two weeks, please reach out to us by email, taxtuesday@andersonadvisors.com, or you can just go to our main website, andersonadvisors.com. Any last words of wisdom there, Kurt?
Kurt: No, I just want to thank everyone for joining us today. It was lovely to be here and join Eliot again. Hopefully, we’ll see you all in two weeks for the next one.
Eliot: Absolutely. Thanks to our staff that helped out here. Again, we had Kenny, Matthew, and Patty helping them with all the tax stuff. We got Dana, Jared, Lanzy, Ross, Tanya, and Troy answering those questions in the background.
Thank you all for joining us. Always great to be here. It’s a pleasure. We certainly appreciate the opportunity to help with your questions. Get those questions in there, and hopefully we’ll be able to pick yours, or at least one similar to it and help you out. Thank you so much.
Kurt: Good day, everyone.
