How you hold your investments and business determines how much of your money you get to keep and what you lose to
- inflation, and
- the middle man.
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Contact an experienced Central Texas estate planning lawyer from The Garrett Law Firm.
Money in traditional and Roth 401(k)s and IRAs grows tax free for years.
A health savings account, investment real estate held in a separate legal entity, and how you receive Social Security benefits and investment income can also lower taxes and increase retirement income.
Some trusts can decrease both your income and your estate tax.
How investments are withdrawn and how they are left to heirs also make a big difference.
When discussing retirement, long-term care, and estate planning with your attorney, talk about how you are investing.
YOUR FAMILY BUSINESS
Over half of the businesses in the U.S., businesses of all sizes, are family businesses. The owner of a business – even a business which holds one small rental property — pays different taxes, receives different tax benefits and faces different opportunities and concerns in preparing for retirement.
If you have started or are thinking about starting a business, whether it is your first, second, or fifth, think about why the business exists and what you hope to get out of it. This questionnaire may help you through the process. What Kind of Family Business?
Choose your company’s legal structure with an eye to
- its purpose and expected longevity
- limiting personal liability of the owners
- limiting and deferring taxes and
- how and when you want to receive salary, benefits, dividends, sales proceeds or retirement income.
A sole proprietorship is the basic way to be your own boss. A sole proprietorship’s name must be registered with the county clerk. A sole proprietorship must obtain liability and other insurance based on the kind of business and its risks. It must collect sales tax. It must pay unemployment, worker’s compensation, Social Security and Medicare tax as both an employer and an employee. It may need to obtain a license.
Its income is taxed as ordinary income. You report the income on Schedule C to your personal income tax return.
There are no employee benefit programs.
There is no separation between your personal assets and the debt and liabilities of your company.
Limited Liability Company, Partnership, Corporation
Limited liability companies, partnerships, and corporations all separate personal assets from business liabilities.
They can all offer employee benefit programs to their owner-employees, deducting them as expenses. Employee benefits which are deductible by the business and not taxed to the employee include
- up to $50,000 in group life insurance
- health and accident insurance
- disability insurance
- long-term care insurance
- health savings account contributions
- employer contributions to 401(k)s and
- other deferred compensation, including a small business 412(e)(3) “catch-up” retirement plan
- employee achievement awards
- meals and lodging for the business’s convenience
- qualified transportation and moving allowances
- adoption assistance program
- cafeteria plans of optional benefits
The first $10,000,000 of the annual earnings of any business is exempt from Texas corporate income tax (the franchise tax, sometimes called the “margin tax”).
Federal tax treatment depends on the form of the business.
Limited Liability Company. A limited liability company is often the preferred way to hold a piece of investment real estate or a small business. By registering the company with the Texas Secretary of State for $300, obtaining an Employer Identification Number from the Internal Revenue Service and maintaining the type and amount of insurance customary for a business of its kind, you can build a fence around your company’s assets and liabilities. That protects your personal assets from the company’s debts and vice versa.
Operating a limited liability company usually requires less documentation and fewer meetings than operating a corporation. A limited liability company is more flexible. It can have one member or several. There is no board of directors. Responsibility lies with the managing members. There could be one managing member or more. Every member could have a right to be involved in management. Or no members might be involved in management; an outside manager could be hired instead.
Profits and losses from a limited liability company with only one member are reported on your personal income tax return, Schedule C, Form 1040, just like a sole proprietorship.
A limited liability company with more than one member can choose to be taxed as a partnership or as a corporation. If it is taxed as a partnership, the limited liability company does not pay taxes: its members do. But only its profits, not its losses, are passed on to its members.
In Texas, if one member has financial problems, these only affect that member. His creditor can go to court for a “charging order,” charging the limited liability company to pay that member’s profits to him. But his creditor cannot vote or become part of management.
Partnership. Family Limited Partnerships are a popular way to keep control in the older generation while providing income to others and protecting their inheritance. The general partner can own a tiny percentage of the business and still be in control.
Liability rests with the general partners in either a general or a limited partnership. Limited partners are not supposed to take an active role. Most general partners are limited liability companies, corporations or limited liability limited partnerships. Any of these structures goes further to protect members’ personal assets.
A partnership agreement can require partners to contribute additional capital or not. Buy-outs, inheritance and ways to terminate the partnership should all be provided for up front. Partnership income tax is complicated. Partnership income tax law can provide opportunities as well as traps.
Partnerships do not pay income tax. Partners do. But partnerships must file a federal income tax information return showing where the money is going.
Like a limited liability company, a limited partnership protects the business from limited partners’ financial troubles. A creditor can receive the debtor limited partner’s profits but cannot vote or become involved in management.
Small or Sub-chapter S Corporation. A small or sub-chapter S corporation has no more than 100 shareholders. No shareholder can be a non-resident alien, another business entity or a trust. A Sub-chapter S corporation is formally organized and operated like a classic corporation but its shares are not publicly held and traded. It can have shares with voting rights and shares without voting rights. Apart from this, it cannot have different classes of shares.
It must choose whether to be taxed as a Sub-chapter S corporation. Then, just like a partnership, it passes both losses and profits on to its shareholders.
In Texas, a disadvantage of any corporation, as compared to a limited liability company or a partnership, is that a shareholder’s creditor could attach the shares and receive not just the right to profits but also voting rights (if those shares had voting rights.)
Classic or Sub-Chapter C Corporation. A classic or sub-chapter C corporation can have any number of shareholders. The shareholders can be individuals, businesses or trusts. Shareholders do not need to be U.S. citizens or residents. The corporation can be privately held or its shares can be sold on a public stock exchange. It can have different classes of shares with different voting rights and different rights to profits.
It can offer more forms of deferred compensation than a limited liability company, partnership or sub-chapter S corporation, allowing owner-employees to spread their income deep into their retirement years, usually saving a lot in income tax.
A corporation can retain earnings for reasonable needs. It should document these to avoid a penalty tax on unreasonably retained earnings of over $250,000.
A corporation pays corporate income tax on its net earnings. It pays 15% on the first $50,000. It pays 20% on the next $25,000. Rates increase with net earnings but expenses such as employee benefits and salaries and loans mean that many corporations show low or no net earnings, paying little or no corporate income tax.
Corporations which do have net earnings divide them between retained earnings and dividends. When shareholders receive dividends or sell their shares, they are taxed at the capital gains tax rate, which is lower than the ordinary income tax rate.
This makes corporations attractive to many business owners large and small.
In forming or re-organizing a business, look at your family’s total tax picture and its current and future needs.
Let an experienced Central Texas estate planning lawyer help you improve your after-tax income, preserve assets and limit liability. Keep what’s yours. 512-800-2420
It’s never too early to plan for your future.