Tom and Nancy agreed to this strategy for the fourplex.
Moving back to their engineering business, Katherine noted that the PC would protect them from other business claims, such as a trip and fall at their office or a claim from a vendor. In those cases, the PC limited their liability. But, she said, to be clear, on a claim of personal negligence they were personally responsible no matter what entity they used. And so insurance was a must.
Nancy asked how the PC would be taxed. Katherine indicated they could choose between S corporation or C corporation taxation. She reminded Tom and Nancy that there was double tax with a C corporation – once on corporate income and then again on dividend distributions. She further noted that if all of the activities of the company were for professional services (i.e. law, health, accounting or engineering) they would be treated as a Personal Service Company and taxed at a flat 35% rate, without a graduation of tax rates as in a regular corporation. On the other hand, with an S corporation the profits flowed through the PC and were only paid at the shareholder level.
Nancy asked about health insurance. She had some medical issues and wanted to be sure she was covered. Katherine said that there was a small advantage with a C corporation. A C corporation could deduct health insurance premiums as a business expense. With an S corporation it was also an expense to the business but for those shareholders owning 2% or more of the shares (which would include Tom and Nancy at 50% each) the premium payments would be counted as personal income to them. So, for example, if their health premiums were $5400 a year in a C corporation that amount could be written off as a straight business expense and thus reduce the corporation’s profit. In an S corporation the business could pay for it and write it off but the $5400 would show up as income on the Green’s personal return. At a 35% tax rate they would pay $1890 in extra taxes.
But Katherine then showed how much they would save by only being taxed once in an S corporation instead of twice in a C corporation. Assuming a 5% state tax and the highest federal income tax rate of 35%, on net income of $200,000 the following is how C vs. S corporation taxation plays out:
The example drove home the point for Tom and Nancy. While they may lose almost $2,000 by being taxed on health benefits in an S corporation they would save almost $20,000 a year by being taxed as an S corporation instead of as a C corporation.
The choice for them was easy. They instructed Katherine to form a professional corporation taxed as an S corporation under the name Green Engineers, P.C. They also had her form a Wyoming LLC to own a newly formed home state LLC to hold the fourplex for maximum protection.
Bobo and Morton
After the Sheriff and the IRS shut down their dog-breeding operation, Bobo and Morton struggled to find a new business activity. Their wealthy, distant parents did not have any ideas this time. The two families had certainly benefitted from the hobby losses while they lasted. But to help the boys actually make money was a different matter. The Trentham and McGill parents did not see much of a future for Bobo and Morton. Early on they had shuttled them from boarding schools to summer camps and back so they wouldn’t have to be with them. And the other Trentham and McGill siblings looked down their aquiline noses on their younger brothers. While the older brothers and sisters were attending well regarded colleges and making their way into lucrative careers they disdained and were embarrassed by, in their highly jaundiced view, their indolent little brothers.
The only champion Bobo and Morton really had was Maddy McGill, Bobo’s uncle’s wife. Aunt Maddy was not a blood relation but she was more warm blooded than the icy blue bloods of her husband’s family. Aunt Maddy had always taken an interest in the two boys. She always made time to catch up with them. She was the only person to ever buy a whippet from them – their only sale in two years’ time.
Aunt Maddy invited Bobo and Morton over to her property for lemonade. After the obligatory small talk she inquired what the boys would do next.
Bobo and Morton had no idea. Aunt Maddy did have an idea.
While they appreciated her thinking of them, the boys were down on themselves. Having barely graduated from high school, they really weren’t qualified to do much of anything.
Aunt Maddy cheered them up. A friend’s daughter who knew all the families had just set up a computer installation and repair service. It was a brilliant move, and good for both the business owner and the customers because everyone trusted each other. Bobo and Morton could do the same sort of thing and the business she had in mind would be perfect for them. She told them that they were both trustworthy, pleasant to work with and their clientele would accept them because they knew their families.
The boys were puzzled. What kind of business was this?
Aunt Maddy proudly exclaimed, “House-sitting.” The boys were at first reluctant. “Sitting at houses?” Bobo asked. Aunt Maddy was certain of it and the boys gradually warmed to the idea. Many of their families’ friends had large estates that needed to be watched over. Many had multiple properties outside the area and were gone from their local estates for extended periods of time. Having some unknown person handle the duties was anathema to most. Aunt Maddy pointed out that Bobo and Morton were already in The Club. Clients would feel much more comfortable working with them.
And so their next business was to be formed. A business where profits would actually be made. A business they could be proud of.
Shortly thereafter, Bobo and Morton went to visit the attorney for both families. Parker T. Ruxton was the silver-haired senior partner of a very large, prestigious and overly wood-paneled law firm. He agreed to see Bobo and Morton only because he cared deeply about keeping the Trentham and McGill business for himself. He cared not for Bobo and Morton. After cleaning up the dog breeding mess he was further confirmed that the two were weak seeded dolts unworthy of their station.
When he met with the boys Ruxton’s tone and demeanor was condescending, sarcastic, patronizing and dour. While many entrepreneurs would not put up with such an egotistical and officious team member, Bobo and Morton just assumed that all attorneys acted that way and stayed on.
Ruxton said they would need a corporation to do business through. Because they were both just over 18 they could now own and manage a corporate entity. A friend of Morton’s had told him that to sound smart he should ask the question, “Should it be a Sí or a Yes corporation?” But when he did, Ruxton demeaned Morton for asking such an ill-informed question. It was not Sí or Yes, but rather C or S. Morton couldn’t tell a difference. Bobo said they sounded the same.
Ruxton cut off any further discussion. They would be a C corporation. He had prepared one under the name Glockenspiel Ventura, Inc. Bobo said he didn’t like that name and wanted to change it.
Ruxton, knowing full well that by amending the articles of incorporation the name could easily be changed, told the boys it couldn’t be done. In truth, several months back, his paralegal had mangled the spelling on the corporate name. The filing was for their firearms client, who wouldn’t pay for the mistake and made them start over, leaving this entity unpaid for and on the shelf. The corporation had passed the 75-day limit for an S corporation filing. So Ruxton took the oddly named C corporation and foisted it on the boys, and charged the families $10,000 for his twenty minutes of trouble. It didn’t matter, Ruxton thought at the time. The ignorant boys would only make trouble, not money...
Rich Dad Tips
• Be sure to consider the tax consequences when choosing your entity.
• With our Social Security system technically insolvent you want to explore ways to legally minimize payroll taxes.
• A good CPA is a good team member to have on your team right from the start.