Limited partnerships, like general partnerships, are flow-through tax entities. The limited partnership files an informational partnership tax return (IRS Form 1065, “U.S. Return of Partnership Income,” the same as a general partnership), and each partner receives an IRS Schedule K-l (1065), “Partner’s Share of Income, Deductions, Credits, etc.,” from the partnership. Each partner then files the K-l with their individual IRS 1040 tax return. A copy of these forms are found at http://www.corporatedirect.com/start-your-own-corporation/.
FAMILY LIMITED PARTNERSHIPS
A word must be said here about the term “family limited partnerships.” There are promoters crisscrossing the country selling an expensive version of supposedly bulletproof asset protection secrets known as the family limited partnership. It is important for you to know: There is no such thing as a family limited partnership! Yes, there are limited partnerships that are used to hold family assets. But, contrary to promoter claims, there is no such creature under any state law as a family limited partnership. They do not exist. So do not pay a lot of extra money for a super-secret, special system that has been fabricated out of thin air. A limited partnership, properly structured, can protect you and be very useful for gifting. You don’t need to pay more for illusory entities.
Following is a table comparing the good and bad entities we have discussed. From there we will further explore the use of C and S corporations, LLCs and LPs.
Rich Dad Tips
• Entities are good when they are legally separate from their owners.
• Corporations, LLCs, and LPs require filing with a state government to obtain that separate identity.
• Sole proprietorships and general partnerships are bad because no such filing is required, and thus there is no separateness to protect you.
S-C-L-L-C!
S-C-L-L-C!
It sounds like a college cheer, something you would hear at a football game. But for entrepreneurs and investors it is more often not a chant but a rant:
S Corporation? C Corporation? Limited Liability Company? What should I do?
By the end of this chapter you will further appreciate certain key differences and will be much closer to making the right choice. Armed with the knowledge gained in this book, you and your advisors will carefully consider the options and select the right entity.
It shall be so.
In our last chapter we explored some of the differences between entities. In this section we will build upon that foundation to erect several structures for your consideration. Please note that we have not included limited partnerships in this discussion. The reason is not due to any unfavorable prejudices against LPs. As in Jim’s case in the last chapter they have great utility. However, the LP requires a corporate or LLC general partner for complete asset protection and thus the filing and maintenance of two entities instead of just one as with an LLC.
As well, aside from that difference, LLCs and LPs are similar and so for ease of discussion we will utilize the more popular of the two—the LLC.
Just as with personal ads, where you need to get to the liking of pina coladas on the beach and disliking of mean people very quickly, the following are key distilled likes and dislikes about corporations and LLCs:
C Corporations
Likes: No limits on shareholders and classes of stock. Lower tax rates on first earnings allowing for future expansion. The best entity for going public. Maximum fringe benefits allowed. Free transferability of stock.
Dislikes: Double taxation on profits, once at the corporate level, next at the shareholder level. Fixed allocation of profits and less flexible management structure. (The same is true for S corporations.)
S Corporations
Likes: Efficient tax treatment. The best entity for minimizing payroll taxes. Charging order protection for corporate shareholders (both S and C) with Nevada corporations.
Dislikes: Must apply for flow-through tax treatment. Can inadvertently lose flow-through tax treatment (see Case No. 6 ahead). Limits on shareholders and classes of stock. No flow-through of business debt. Fixed allocation of profits.
Limited Liability Companies
Likes: Excellent asset protection via charging order rules in Nevada and Wyoming. Flow-through of business debt. Flexible allocation of profits. Flexible management structure.
Dislikes: Difficulty of minimizing payroll taxes. Extra state taxes in California. Newer entity with less case law to interpret future events. Less free transferability of interests than corporate stock (some may see this as an advantage).
Using these guidelines, let’s apply them to the two main reasons for forming an entity:
1. To operate a business
2. To hold assets
Operate a Business
When it comes to choosing the right entity for operating a business several factors must be considered.
While both corporations and LLCs offer limited liability protection, that issue will be fully discussed in the next section. For now, in the business context, the first issue is:
Payroll Taxes
Salaries paid to employees (including owner-employees) are subject to FICA and Medicare taxes, otherwise known as payroll taxes. (For the current taxable limits visit www.corporatedirect.com/accounting.html.) At 15.3 percent of payroll, these taxes will be one of the largest expenses a business will have. If you are savvy you have not bought into the argument that these taxes are “only” 7.65 percent of payroll. If you own the business you are paying both halves of that, or a whopping 15.3 percent on all of your payroll. Given that our Social Security system is near bankruptcy and that citizens under forty may never see any of the promised benefits, it becomes important to consider how to best minimize payroll taxes.
In a C corporation, which features a double tax on profits, it makes sense to pay as high
