“Choice Of Entity – Active Business And Real Estate New Business Ventures” by John M. Carnahan, III
The choices of business entities are now almost too long to list. There are several historical ones, as well as some fairly recent ones, which have now become the entity of choice The alternatives include:
- C Corporation
- S Corporation
- General Partnership
- Limited Partnership
- Limited Liability Limited Partnership
- Limited Liability Company
- Series Limited Liability Company
- Professional Limited Liability Partnership.
Once again there are other types of entities, some which have very limited use, for example Professional Corporations for law firms, accounting firms, and dental practices.With the recent increase in income tax rates, and the implementation as of 2013 of the Medicare Surtax (3.8% on certain types of investment income), dramatically increased exemptions for Federal Estate Taxes, and a strong likelihood of additional tax law changes in the future, the choice of your business entity as you set up a new structure for an active business becomes far more important. The income tax planning aspects, especially minimizing exposure to the Medicare Surtax, the double taxation involving C Corporations and so fort is far more important than it was during the period from the Reagan tax period through the end of the Bush tax cuts.
Your goal is to minimize exposure to double taxation, application of the Medicare Surtax, as well as getting any benefits that might result in the future as a result of the death of an owner. For example, a step-up-in-basis in both the outside ownership interest as well as what is known as a Section 754 Election to increase the basis inside a pass-through or partnership type entity. In some cases you can depreciate assets three times including when you first purchased it, on the death of the first to die of a husband and wife, and then on the death of the survivor as the asset pass downstream to children and grandchildren. The ability to re-amortize or re-depreciate assets which have already been depreciated once is an extremely beneficial tax planning tool.
One structure, that we are seeing more of in our practice, as clients come in to discuss either an entity to acquire an active business with real estate or the parties are setting up a new business, involves a Limited Liability Limited Partnership wherein the General Partner is a Limited Liability Company which makes a Subchapter S Election. Underneath the Limited Liability Partnership you set up at least two single member LLC’s, one to conduct the active business and isolate the liability there and the second to own the real estate which is then leased to the active business. This allows you to avoid the Medicare Surtax on rental income, which is very difficult to plan around, and at the same time move the income upstream with a large part of it not subject to Social Security taxes, and at the same time hopefully having the majority of the owners active participants and employees of the general partner receiving salaries and thus minimizing the exposure to the Medicare Surtax on the total income from the business enterprise.
This type of structure takes more planning, but it minimizes the need for annual meetings of shareholders and directors, possible application of franchise taxes, as well as offers maximum flexibility from an income tax planning standpoint and certain benefits, in the event of the death of an owner.
Any of the members of the Transactional Group of Carnahan, Evans, Cantwell & Brown, P.C., would be more than happy to discuss with you, your family and business partners, the possible use of this fairly new business structure for future transactions.