Real Estate Investment – The Perfect Guide For Beginners

by Kausar Khan

Those people who don’t know anything about real estate, for them this concept can be a very intimidating theory. However, those people with experience in the real estate field as well as through their own research learned about its basics, they do benefit a lot from this concept. Nonetheless, those people might need some starting steps, which are new to this area. Therefore, I have written this article for those people, in which I will provide you few tips through which they could not only learn about real estate investment but also will be able to feel comfortable doing so.

Research about your subject, which is the real estate, this is the very first tip you must consider. The basics of the real estate area are necessary to be understood before one start investing. Various forms related research of this concept is one thing you can engage yourself in. Furthermore, you can also find information about this concept online, you can also read books about it, or you can even go to classes for this concept. Buying and selling real estate must be the first thing you should research about, before moving further in advanced research to arrange your investment in such a manner so that you could gain from it either through renting or selling of a property.

The second tip is that you must determine your targets related to real estate investment. Moreover, you must also determine that what you have planned to obtain through investing in the real estate. The choice is yours, what is it you want, either it’s the enjoyment or the money or both. Furthermore, also decide whether you are going to buy the property by yourself, or you want to have partners. Moreover, you must also decide whether you want to fix up the property and sell it to gain money, or you want to rent the property by keeping it and gaining money.

Advice of real estate attorney and investment advisor is the third tip for you to consider. In order to do everything correctly while investing in real estate, advice from the professionals can be immensely helpful. In terms of handy, real estate attorney and investment advisor are the best people who could help you while your investment process. Whether the purchase is legal or not is what a real estate attorney tells you, while how to structure your investments is what an investment advisor tells you. If you want to be on the right track of real estate investment, then the advice and support of these two people are the most important for you.

What is the fourth tip? The fourth tip is determining the amount of money you contain and could spare for investment in real estate. Why is that so important? It is important because during the life of investment you will have to spare some money for repairs, improvements, taxes and other such things. Hence, you must have a spare fund available to tackle such kinds of encounters during the life of investment. What are the fifth and the last tip? The fifth tip is keeping your eye on your main goal of investment. What does that mean? That means you must remind yourself constantly to keep yourself on track and could climb the ladders of success of the real estate investment.

I am Kausar Khan. If you having any query about Prince William homes for sale or general real estate problems, please visit my website house for buying. I also give some really interesting and proven tips on getting perfect and dreamed real estate.

Posted in Real Estate | Tagged , , , , , , , | Leave a comment

Tax Sales, Tax Certificates, Tax Deeds: Due Diligence Matters!

By: Darius M. Barazandeh, Attorney at Law / M.B.A.

We have all heard the ‘infomercial’ and the Internet claims regarding tax foreclosed property:
• “You will own the property FREE and CLEAR!”
• “
All other liens and interests are WIPED OUT!”
• “You will hold the FIRST PRIORITY security interest!”
• “The Government Guarantees these properties!”
• “All liens, interests, and encumbrances are ERASED!”
• “You can do this part-time with nothing down!”
• “You don ’t need to set up a company … just get out there and make a deal!”
While this can make great marketing material it is not in accord with the reality of tax foreclosure purchases. As an attorney, I learned in law school that every rule of law has an exception. Knowing how these exceptions work will mean the difference between success and failure as a real estate investor on the grandest of scales! I don’t make that statement lightly, rather I make it with as much of the emphasis and weight that the English language will allow. Please read it again, “Knowing how these exceptions work will mean the difference between success and failure as a real estate investor on the grandest of scales!” If you intend to be successful you must be able to separate marketing fluff from well researched and analyzed fact. If you rely on marketing materials and hype your failure is nearly certain, however if you rely on well researched information formulated into a methodology then the keys to success in any endeavor are in your hands.

What Does This Mean to Me and Why Should I Care?
What this means is that you must forget about blanket marketing statements when dealing with tax foreclosed property. For every statement that is contained in the bulleted list (at the top of the page) there is an exception and just like any business what you don’t know WILL hurt you. If you have contacted me by email or purchased one of my courses you know that I absolutely believe in covering all the positive and negative aspects of investment techniques. This does not mean focusing ONLY on the benefits or making wild claims about investment techniques. It DOES mean thoroughly covering what could go wrong and a relentless approach to risk reduction.
In the following sections we will review some of the areas that you must consider when researching and evaluating tax sale properties. I call them due diligence areas #1 through #5. These are not an exhaustive list but they do set out some of the areas which are typically left out of most people’s analysis. For a complete list please review my course materials.

Due Diligence Area # 1:
What Liens Will Survive Foreclosure?
One area that really upsets me is when I hear a general rule of law blindly applied to every tax foreclosure situation with reckless abandon. Whenever you hear that the foreclosure of a tax lien ‘wipes out all over liens’ or that the property is now ‘free and clear of all other liens’ a general rule has been overstated. The general rule can be found in the property code of every state and the UCC (Uniform Commercial Code) which covers commercial transactions. The general rule can be stated as: The foreclosure of the superior lien will eliminate the rights of any junior interests in the realty or personal property. This general legal rule stands for the proposition that: that when a superior lien (one that was recorded or ‘perfected’ before all others) is foreclosed (i.e., through the state’s legal foreclosure guidelines) any junior interests will lose their interest in the property. Remember that there are exceptions to this general rule.
Let me give you an idea of some of these exceptions:
1) Federal Tax Liens – Since most liens on a property will likely be liens from the state or a municipality within the state you must be aware of the possibility of a federal tax lien. You can ask your title company to search for this, however a good title company should spot this lien pretty quickly.
2) State Income Tax Liens – Some states which have a state income tax may give priority to any liens for unpaid state income taxes. As the purchaser of the property or the holder of the lien you could still have these liens surviving as encumbrances on your property even after foreclosure.
3) State Sales Tax Liens – Unpaid state sales taxes can result on a lien which attaches to the property of the delinquent taxpayer. You should contact an attorney to find out if your investment state has a sales tax lien which could survive foreclosure.
4) Mechanics Liens and Materialmen’s Liens – Work performed on the property where improvements or repairs are made can result in a mechanics lien if payment is not made by the party who contracted for these services. You will find many different names for this type of lien, for example: mechanics liens, materialmen’s liens, artisans liens, workers liens, etc.
Don’t forget to learn more about your investment state as your state could include others or exclude some of these liens. Don’t be scared off by this list, BUT glad that you are now informed about this potential risk. Since you have the knowledge you need only perform adequate research to avoid the risks in this area.
Due Diligence Area # 2:
Are Environmental Risks Associated with the Property?
In some instances you can run the risk of purchasing someone else’s environmental liability. Congress passed the ‘Superfund Act’ (42 U.S.C. 9601 et seq.) which made every landowner liable for previous environmental contamination on a property regardless of whether they caused the damage or not. There is some good news for lienholders since Congress has given them an exception from liability if you are a lienholder not considered an ‘owner or operator’. Court rules and interpretations have been changing regarding this issue so don’t risk it. I want to be sure my liability is limited therefore I believe in being extra cautious when dealing with commercial properties in the tax sale setting. If there is some question as to the area or type of business conducted on the parcel you should contact an environmental specialist and ask some preliminary questions about the area and property you are investigating.
If you want to steer clear of the whole issue then you should avoid commercial properties all together. The chances of environmental damage found on residential properties in zoned subdivisions is much less. I do tell my students to avoid commercial properties unless it’s a really good deal. Naturally if it is a good deal you can afford to do the extra research to make sure there are no environmental problems on the property.

Due Diligence Area # 3:
What About Other Fees Not Included in the Foreclosure?
You should always get an idea of whether there are any other fees or dues not included in the foreclosure purchase price. I know this sounds odd but it can occur if an entity that is owed money was not included in the tax foreclosure lawsuit. If they did not get notice or did not decide to ‘join’ themselves in the collection lawsuit then the money simply won’t be added to the opening bid amount. The purchaser of the property would still be responsible to pay for these fee amounts.
Here is what I suggest that you do:
Contact the tax collection entity or authority (typically the tax assessor)
Ask them which entities they collect taxes for
Then ask which entities are outside of their collection area
Create a list of entities whose taxes are not collected by the assessor BUT may still be owed by delinquent taxpayer
Call and ask the entity the amount of back taxes, dues or fees
Add this amount to your bid analysis

Again, by following a simple step-by-step methodology you can greatly reduce you risk and boost your success rate ten fold. Make sure you go through this checklist of tasks with every property you consider purchasing.
Due Diligence Area # 4:
Bankruptcy of Delinquent Property Owner
You must check to see if there is a looming bankruptcy associated with the property. I see very few tax sale products covering this issue. This is an ABSOLUTE MUST in your analysis of any property. You can access federal bankruptcy records through the federal bankruptcy court in your state. Some of these records may be online. There are generally two main possibilities that you must be wary of:
1) A Bankruptcy has occurred prior to purchase – Sometimes you will find that a property is tied up in a bankruptcy administration while it is being prepared for tax sale. You should avoid properties which are on a tax sale list which have a pending bankruptcy suit.
2) A Bankruptcy has occurred during the redemption period – This scenario can be problematic as well. Here the property has been sold to tax sale investor but while the redemption clock is ticking the delinquent property owner has declared bankruptcy. Now a trustee has been appointed to protect the assets of the estate. The biggest risk to the tax sale purchaser is that the trustee will attempt to argue that the tax sale purchase was a ‘fraudulent transfer’. For such an activity to occur there must at least some dealing or scheme between the debtor and the purchaser such that an attempt is made to avoid liquidation of the estate by transferring property to a 3 rd party. While the tax sale purchase really should not be classified as such a transfer if the trustee raises this argument it can interfere with the tolling of redemption period, your ownership rights and the final disposition of the tax sale property or lien. Keep in mind that if the trustee wins this argument you won’t lose your initial investment, but you will lose any of the anticipated profit. It is not an easy argument for the trustee to win but just be wary of this possibility.
The best thing to do is to avoid situations where you know the property is involved or will be involved in a bankruptcy. You should check in the owner’s district of residence for any bankruptcy filings. Lastly, don’t be too frightened by this issue because doing your research will help you greatly reduce your risk of being affected by a bankrupt estate.
Due Diligence Area # 5:
Doing Deals in Your Own Name
This is an area that is very critical to apply and apply correctly. If I could refuse to sell my products to someone who does not have a legal business entity from which they will make these purchases, I would do it. That means that if I find out you are buying tax sale property in your own name I will come and take my course from you! No seriously…this is a very critical issue and I just want you to understand how much it worries and keeps me up at night knowing that some of you will ignore my advice and buy tax deeds as ‘John Jones’ instead of ‘Jones Real Estate, Corp.’
Why is this such a bid deal? The reason is that when you purchase a property as an individual you are now personally liable for the anything that goes wrong with the property. This could include someone getting hurt on the property (yes, even a trespasser can sue you), environmental issues with the property, liability from ‘unknown’ liens, and a myriad of other problematic scenarios.
However, when you form an entity you generally will not be personally liable for these acts, omissions, or hidden liabilities. What will happen is that the corporation, partnership, or LLC will take the hit. Now why did I say that ‘generally’ you will not be liable? I said that because if you do not maintain the entity using the proper formalities you will lose that protection. In a landmark business law case the courts determined that to “preserve equity and prevent injustice” it could “pierce the corporate veil” and hold the shareholders or owner(s) liable for the acts and/or omissions of the corporation if proper formalities were not met.
If you go to any real estate investing seminar and they tell you, “Just do a deal or two then worry about forming your company”, please run out the door! It will only take one bad deal to make you liable thereby risking everything you own. Before you attempt a deal you should find an attorney to help you determine which form of business entity will serve you:
Corporation – C-corp or S-corp.; or
Limited Partnership (LP); or
Limited Liability Limited Partnership (LLLP); or
Limited Liability Partnership (LLP); or
Limited Liability Company (LLC)
You should then have the entity up for you and teach you how to maintain its formal status in the eyes of the law. I have helped individuals with the matter and I can tell you that you must have an attorney who will listen to your needs and spend time educating you. The reason I think education is important is that if you don’t maintain the entity correctly its the protective shield will not exist in the eyes of the law. It will be as if you never incorporated at all. What good will the slick corporate minute book and fancy company logo be if the attorney did not teach you how to keep the entity separate from your personal dealings? Unless your attorney takes the time to teach you how to maintain your entity status it will be worthless.
I want to wish you the best of luck in your endeavors and email me if you ever need help!

Article Source:

Posted in Entrepreneurship, Real Estate | Tagged , , , , , , , | Leave a comment

Trying to Sell Your Home by Yourself? Know About FSBO

By James K Allen

People who want to sell their home would sell through for sale by owner if they want to save some money and have a successful sale. People try very to save the money in any way possible. They never want to spend on real estate commission if they don’t have to. Many people don’t believe that FSBO is like a big opportunity for them to sell their home. They don’t even try to know how it helps them in the selling process of their home. Sometimes, they even afraid of selling their home by themselves because they think they might mess up something very important. Reasons for these doubts could be anything. Hearing a sad FSBO story or following the status quo and get help from real estate agent in the selling process. But they never think how this FSBO process helps them to sell their home.

Selling your home through FSBO is not an easy process but once you know the details, steps how you can proceed to succeed then it becomes very easy for you to sell your home and also you can do the sale by yourself without any help from real estate agents or brokers. If you are selling your home through FSBO, it is not just a single benefit of getting the price you want for your home, it has also some other benefits like selling your home faster than you expected, no stress in the selling process, finding the buyers who actually love your home like you, finding how actually advertising helps you in the selling process of your home and many other benefits.

This FSBO process is often criticized by many real estate agents and brokers because this process creates a parallel real estate network in which house owners are the real estate agents. Because of this reason, they don’t even show houses that are being sold using “for sale by owner”. The main reason for this s that they think they will have to do twice as much work. In many cases they are right. It is an excessive burden for the buyer’s agent to have to hold the seller‘s hand and educate them through the selling process.

So if you want to sell your home through FSBO successfully, please take time and learn what you needed to know before even starting the selling process.

Article Source:

Posted in Real Estate | Tagged , , , , , , , | Leave a comment

Tax Lien Investing Basics (Part Two)

by Lillian Villanova

Once you know the date, time and terms of a tax sale, get a copy of the list and start researching properties. I realize you may be holding a list with descriptions of hundreds–even thousands of properties. And I know that if you are unfamiliar with real estate it looks like page after page of unintelligible words and numbers.

It is actually fairly simple to read once you “crack the code” so to speak. This may seem like an impossible task, but it works if you just break it down into manageable parts. As you look at the list, get beyond the fact that there are thousands of parcels and get over the feeling that you will never get through all of it.

Think of it as a treasure hunt for interest rates that are double or triple what you are earning now. You don’t have to get through all of them, just find the ones you might want to buy.

For many counties, you can do much of your research on the Internet. Each parcel that has an unpaid real estate assessment on it is identified by a number. As you get more proficient in looking at these lists you will be able to pick out neighborhoods just by looking at these numbers.

Start narrowing your list

Whether it is called a Tax ID #, or a Folio #, or a Parcel #, or a Real Estate # or something else, the function is the same–to identify that parcel and to assist anyone trying to obtain information on that parcel. That number will normally be all you need to:

  1. Find the legal description if it is not already set forth on the sale list
  2. Find the property address
  3. Find the owner’s name
  4. Find the assessed value
  5. Find the size of the parcel and what if any structures or improvements are on it

Sometimes you can look up similar sales and come up with a fair market value by looking at comparables. How do you narrow down the list? Start with your own initial investment budget. You may want to try and buy more than one certificate to “diversify.”

If you only have a few thousand or even only a few hundred dollars to invest, you can immediately eliminate the larger properties. Remember that although statistically more than 95% of tax lien certificates redeem, you may be one of those whose certificate is not.

Think about this when you are deciding which tax lien certificates to buy: Do you want improved or unimproved property? Do you want residential or commercial property? Do you know which parts of town are more or less desirable? The property descriptions will give you the answers to these questions.

Once you have narrowed your list to the tax lien certificates you are actually interested in, you can either go Online to the county web site or visit the County Land Records office to continue your search. Take into account that there may be tax liens from previous years attached to the property.

Ensure your success

Your goal is to find properties that are worth far more than the back taxes owed. This would virtually guarantee one of two things: Either the owner will find a way to pay the taxes to avoid losing the property, or you will obtain a property that can be sold at a profit. If you keep to that conservative mindset, you are assured success.

Make sure you understand the bidding process and how it will works in your state. In some states, such as Florida or Arizona, the bidding starts at the rate set by the statute and each bidder bids a lower interest rate.

For example, as of this writing, the maximum allowable interest charge on a tax lien certificate in Arizona is 16%. So, the opening bid on each certificate would be 16%. Participants would bid 15 1/2% , 15%, etc. until the lowest interest rate someone is willing to accept is reached. That person has now purchased that tax lien certificate at that ending rate.

The delinquent taxpayer still must pay the full statutory rate, and the county keeps the spread. In some states the auctioneer is auctioning the percentage of interest in the property. If the face amount of the certificate (representing the back taxes) is $5,000, the certificate cannot be for more than $5,000.

The opening bid would be that $5,000 amount. If there is competitive bidding at this point, the bidders will bid for a smaller than undivided interest in the property. The person willing to take the smallest interest in the property will become the certificate holder.

Under this system, bidders who want certificates paying the statutory rate, competitively bid down the amount of property he or she would actually control in the event of a foreclosure. If bidders bid down the amount of interest they control in the property, they could own only a less than 100% down to 1% interest in the delinquent property to the owner’s 1% to 99%.

It’s important to understand that the bidder is buying delinquent taxes. They are buying an interest rate and in the unlikely event of a foreclosure, they would own only the portion they bid down to. The tax lien certificate the bidder purchased would still pay the full statutory rate the state mandated by law.

In Colorado, the system results in a premium bid in many cases. In states using this system, the law allows the amount of the certificate to be bid up. There is a statutory rate of interest that is paid on the face amount of the certificate, but the bidder may pay more than the face amount for that certificate.

For example, a $5,000 tax lien certificate could be bid up to $6,000. The excess or surplus bid would reduce the bidder’s yield. The bidder will receive the highest interest the law allows, but the premium paid (in this case $1,000 surplus overbid) goes to the county general fund. Thus when a bidder overbids and pays the bid amount but only receives the face amount back that bidder automatically has a decreased yield.

This is one of the reasons why it is so very important to understand the process BEFORE you bid. Lastly, a tax lien certificate could be bid up to a higher dollar amount and the total bid price returned to the property owner, plus interest. So if the price of a $2,000 certificate is bid up to $3,000, the property would have to pay back the $3,000 plus statutory interest to redeem the property.

It is not a complicated process once you understand it, and it makes much more sense if you attend an auction and see how it works firsthand. Even if you do not plan to bid, you should attend at least one auction. It is the best way to see how simply it works.

You don’t need a ton of money to get started

If you do not have money to invest but want to get started, ask friends or family if they might want to invest. You will be surprised at how many people will be interested when they hear how they can make a secure 16% (Arizona), 18% (Florida), or more (Iowa) on their money.

Treat the arrangement like the business venture that it is, and enter into a written agreement. Even with the best of intentions unforeseen events can create problems. Did you mention everything? Did your investor understand exactly what they were agreeing to do?

Think about arguments you have had where there had obviously been a miscommunication. Think about the times when you started a project with someone having the best of intentions and had something unforeseen happen to create a problem. Remember all the stories you hear about problems other people have had because they were sloppy about setting up an agreement?

Learn from their mistakes. You want your investor relationships to be long-term and run smoothly. Lay the proper foundation and odds are they will.

Posted in Entrepreneurship, Real Estate | Tagged , , , , , , , | Leave a comment

Tax Lien Investing (Part 1)

Foreclosure auction signs

Image by niallkennedy via Flickr

by Lillian Villanova

If you take the time to learn the ropes, you’ll discover why real estate is the best wealth-builder in the universe–the safest, most accessible, most lucrative investment you can make. You’ll also find out how to use your real estate investments to create multiple income streams and have a river of money flowing your way every day.

As an example, do you know how to invest in Tax Lien Certificates and Tax Deeds? Briefly, state, county and local governments raise money to provide benefits and services via taxation. One type of taxation, is a tax on “real property.” Pursuant to statute, the owner of a parcel of real property is assessed a dollar amount to pay based on the value of that real property.

This tax, in virtually all cases, is collected by the county where the property is located. If the owner of the property fails to pay the tax, the amount of the tax becomes a lien against the property. A lien against the property, however, does not help the county and local governments pay for the services and benefits they have promised to provide for their citizens.

The county needs the money now, not some time in the future. It needs that money in order to fulfill its budgetary obligations. By state statute, each county is authorized to collect the taxes due that remain unpaid by selling at public auction, either a Tax Lien Certificate or a Tax Deed.

Learning how to buy these Tax Lien Certificates and Tax Deeds is a very real way to achieve financial independence. The aim of this and the following articles is to help you understand, in layman’s terms, how the process works and how you too can learn to use it successfully.

If you ask most people, you will find that very few of them even know that this form of investment exists. It is not well publicized; banks and brokerage houses have no incentive to tell you about it; and people who are doing it consider you competition.

So how do I get started?

How do you acquire the information and skills you need to make money? While the process is not difficult, it does take a consistent and focused effort. You are the only one who can create your success, and you can do it. Start by learning everything you can about investing in either Tax Lien Certificates or Tax Deeds. Don’t try to learn everything all at once.

There are over 3,000 counties in the United States, and each one of them has something a little different about the way they do things. There are some good books on the subject, including my own, and many of the counties have a wealth of information you can obtain for free. A good place to access the various counties across the US is

There are a number of approaches you can take at this point. If you have very limited capital or are strictly looking for a guaranteed rate of return on your savings or investment portfolio, you may wish to concentrate on Tax Lien Certificates.

If your ultimate goal is to buy and sell real estate or to build a portfolio of investment properties, then you may wish to concentrate on attending Tax Deed Sales. As you become more comfortable with the materials and your knowledge of how they can work for you, your strategy can be modified. But for now let’s keep it simple.

Set up a series of simple steps designed to get you to your ultimate goal, and then go for it. Try this as a start. Contact the Tax Collector or Treasurer’s office in your county and find out the answers to the following questions:

1.      When will the county be conducting the next Tax Sale?

2.      Where will the sale take place? (Get the address, room, and time of sale)

3.      How can I get a list of the Tax Liens/Properties to be auctioned? (Sometimes, the county will have copies available at their offices. Most likely they will refer you to a local newspaper that prints the sale notice and list of properties or liens to be sold)

4.      How can I get the Rules of the Sale? (The terms and conditions of the sale including pre-registration requirements and methods of payment).

5.      If a it’s a lien sale, what is the interest rate? How is it calculated?

6.      Does the county have any unsold Tax Lien Certificates or properties from the last sale?

The answer to the above question is usually “yes.” At which point, you should ask how to see a copy of that list. Then go review the list! Many counties have THOUSANDS of unsold certificates.

I recently picked up a list of unsold certificates from one county in Florida, and it was 905 pages with approximately thirty-two liens per page. Just that list represented millions of dollars worth of delinquent taxes.

If the answer to this is “no,” ask the next question: What happens to any unsold Tax Lien Certificates? Many times, they will respond in a manner that gets you the answer you want. “Such and such department keeps that list” or “They are held by the county.”

Don’t be intimidated or discouraged if initially you get the answers you need to move forward. Be polite and persistent. Again, call and ask for this information from more than one county. The information you get will vary from one county to the next, and you will start to become familiar with the terminology used in your state and counties.

There are a number of counties in Florida with no unsold Tax Lien Certificates. If I had stopped at one call, I may not have gotten the opportunity to buy thousands of dollars worth of certificates at 18%. Now that you have gathered the information, part two talks about how to get ready for a sale.

Posted in Entrepreneurship, Real Estate | Tagged , , , , , , , , , | 1 Comment

S Corp. vs. LLC: Which Structure is Right for Your Business

by Chrissie Mould

Determining the type of legal structure for a new business can be daunting for entrepreneurs and small business owners. Corporations and limited liability companies (“LLCs”) are preferred business structures because, unlike sole proprietorships and partnerships, both offer liability protection. This means that the owner of a company cannot be held personally responsible for the company’s debts. The personal assets of an owner are shielded from company liabilities. In researching the various business structures, one inevitably comes across the S corporation. S corps and LLCs are similar in that they are both “pass-through” entities for tax purposes; the income of these companies are passed through to their owners and reported on the owners’ personal income tax returns, thereby eliminating the double taxation incurred by owners of a standard corporation, or C corporation. (With a C corporation, the net business income is subject to corporate income tax, and the monies remaining after the corporate income tax are taxed a second time when they are distributed as dividends to its owners who must then pay personal income tax.)

So what is the difference between an S corporation and an LLC? And which structure is right for you?

The answer depends on your own unique situation. If operational ease and flexibility are important to you, an LLC is a good choice. If you are looking to save on employment tax and your situation warrants it, an S corporation could work for you.

Business Ownership & Operation

There are restrictions on who can be owners (called “shareholders”) of an S corporation. An S corporation can have no more than 75 shareholders. None of the shareholders can be nonresident aliens. And shareholders cannot be other corporations or LLCs.

An S corporationis operated in the same way as a traditional C corp. An S corp. must follow the same formalities and record keeping procedures. The directors or officers of an S corp. manage the company. And an S corp has no flexibility in how profits are split up amongst its owners. The profits must be distributed according to the ratio of stock ownership, even if the owners may otherwise feel it is more equitable to distribute the profits differently.

LLCs offer greater flexibility in ownership and ease of operation. There are no restrictions on the ownership of an LLC. An LLC is simpler to operate because it is not subject to the formalities by which S corps must abide. An LLC can be member-managed, meaning that the owners run the company; or it can be manager-managed, with responsibility delegated to managers who may or may not be owners in the LLC.

And the owners of an LLC can distribute profits in the manner they see fit.

Let’s say, for example, you and a partner own an LLC. Your partner contributed $40,000 for capital. You only contributed $10,000 but you perform 90% of the work. The two of you decide that, in the interest of fairness, you will each share the profits 50/50. As an LLC you could do that; with an S corporation, however, you could only take 20% of the profits while your partner would take the other 80%.

Employment Tax: Savings vs. Paperwork

A major factor that differentiates an S corporation from an LLC is the employment tax that is paid on earnings. The owner of an LLC is considered to be self-employed and, as such, must pay a “self-employment tax” of 15.3% which goes toward social security and Medicare. The entire net income of the business is subject to self-employment tax.*

In an S corporation, only the salary paid to the employee-owner is subject to employment tax. The remaining income that is paid as a distribution is not subject to employment tax under IRS rules. Therefore, there is the potential to realize substantial employment tax savings. Case in point:

Mary owns a print shop. In keeping with the industry standard, Mary decides that a reasonable salary for a print shop manager is $35,000 and pays herself accordingly. Mary’s total earnings for the year are $60,000: $35,000 paid in salary and the remaining $25,000 paid as a distribution from the S corp. Mary’s total employment tax is $5,355 (15.3% of $35,000).

If Mary were the owner of an LLC, she would have to pay employment tax on the entire $60,000, equaling $9,180. But as an S corporation, she realizes savings of $3,825 in employment tax.

One might assume that these savings could be further manipulated by reducing the salary to an extremely low amount and attributing the rest of one’s earnings to distributions—but this would be an incorrect assumption. In practice, the IRS is careful to notice whether a salary is reasonable by industry standards. If it determines a salary to be unreasonable, the IRS will not hesitate to reclassify distributions as salary.

Still, while the potential employment tax savings may make the S corporation an attractive structure for your business, bear in mind that you would then have to deal with all the paperwork associated with payroll tax. The payroll tax is a pay-as-you-go tax that must be paid to the IRS regularly throughout the year–on time, or you will incur interest and penalties. The paperwork alone can be an overwhelming task for someone who is not familiar with this; and if you expect to incur losses or otherwise experience a cash flow crunch during the year that would hinder you from paying the payroll tax when due, this could present a problem.

Owners of LLCs pay their self-employment tax once a year on April 15 when income taxes are normally due. Income tax filings are also relatively easy for the owners of an LLC: A single-member LLC files the same 1040 tax return and Schedule C as a sole proprietor; partners in an LLC file the same 1065 partnership tax return as do owners of traditional partnerships.

The comparison chart below sums up the similarities and differences between the two business structures:

S Corporation Limited Liability Company
Liability Protection Yes Yes
Operational Control Board of Directors/Officers May be member-managed or manager-managed
Federal Income Tax Pass-through Pass-through
Flexibility/Ease of Operation No; subject to some formalities and record keeping rules as traditional C corps Yes
Ownership Restrictions Yes No
Flexibility in Profit-Sharing No Yes
Employment Tax Employment/payroll tax on salary; no employment tax on dividends paid to shareholders Self-employment tax on total net income *

There is no one, magical entity that works for everyone. A CPA or a specialized tax attorney can assist you in choosing the right structure for your business. The important thing is to consider the operational, legal and tax aspects of each structure as they apply to your unique situation.

* The self-employment tax rate for 2009 consists of two parts: 15.3% for social security and 2.9% for Medicare. In 2009, only the first $106,800 of total net income is subject to the social security portion of the tax. All of the the total net income is subject to the Medicare portion of the tax.

*For those who prefer the tax treatment of an S corp but like the simplicity of an LLC, there is an alternative worth considering: Forming an LLC that is taxed as an S corp. An LLC may make a special election with the IRS to be taxed as an S corp. This election is made on IRS Form 2553 and must be filed with the IRS before the 16th day of the third month of the tax year in which the election is to take effect.

An LLC that is taxed as an S corp is still a limited liability company from a legal standpoint (subject to the laws governing limited liability companies in the state of formation); however, for tax purposes it is treated as an S corp.

A word of caution: Certain nuances of S corp taxation can be confusing to some LLC owners, especially do-it-yourselfers and/or those who prepare their own tax returns; for example, an LLC owner might easily make the mistake of referring to an IRS publication that addresses LLCs when, in fact, such a publication would not apply to an LLC that is taxed as an S corp–and such an error could lead to negative tax consequences. It is therefore highly recommended that you consult a CPA or other qualified tax professional for advice and/or assistance.

Posted in Entrepreneurship | Tagged , , , , , , , , , , , , , , , , | Leave a comment