7 reasons to file a separate tax return for an LLC

Michael Plaks, EA writes: Limited Liability Companies, better known as LLCs, are the most common business entity, especially in Real Estate. Many LLC are owned by a single person or by a married couple – which, in the community property states like Texas, are considered a single owner. Typically, such single-member LLCs are treated by the IRS as “disregarded entities.”Strangely, it means exactly what it sounds like: the IRS completely ignores such LLCs and does not want any tax returns from these disregarded entities. Instead, all income and expenses from single-member LLCs are reported on the owners’ personal tax returns, as if there was no LLC at all.

Yet, some LLCs do file a separate tax return. We will discuss the 7 reasons why you may decide to do so.

1. Professional appearance

Just that: appearance. Ironically, this is the most common reason to file a separate tax return for an LLC. Somehow, to some people it just feels more serious and proper to isolate all LLC numbers on a different tax return. However, there is no substance here, just a prettier packaging. You can sense that I’m not a big fan of this superficial thinking.

2. Multiple owners

Now, this one is a completely valid reason. The only type of LLCs that can be disregarded by the IRS are single-member LLCs, including husband-and-wife LLCs. If you own LLC together with somebody other than your spouse, then it is a multi-member LLC, and it must file a separate tax return. Usually, it should file a partnership tax return, unless you specifically elected to be treated as a corporation.

3.  Financing considerations

Your lender may request that you file a separate tax return for your business, on order to qualify for a loan. This is fine, just keep in mind that you’re doing this strictly to please your lender and for no other reason. There are no rules here, and whatever rules exist – they change all the time. A different lender (or even the same lender at a later time) may have different requirements. This is how lending works.

4. Financial aid eligibility

When you or your kids apply for financial aid, reporting your business separately can sometimes make a difference in your eligibility. Especially when we’re talking about rental properties. Financial aid is not my area of expertise, so make sure to consult a specialist. Just remember that it may matter.

5. Asset protection

Liability protection is the most common reason to create an LLC, in the first place. Some attorneys believe that filing a separate tax return is essential to ensure you do have proper legal protection. Maddeningly, there is never a consensus when it comes to attorneys. They never agree of anything, and I’m in no position to decided which one of them is correct. If your attorney tells you that your LLC needs a separate tax return, so be it.

6. IRS audit risk

I hear this argument very often: partnerships and corporations have lower risk of an IRS audit, compared to personal tax return, percentage-wise. Yes, it is true. The question is: is it an important enough concern to justify the extra hassle and cost of filing a separate tax return? I am not sure that it is. No matter what you do, you always have some chance of getting audited by the IRS. Unless your numbers are out of the ordinary in some way, the odds of being audited are pretty low. Reducing an already low risk to an even lower risk would be a good idea – if it did not involve more work and more cost. You decide.

7. Tax savings

Finally! Who does not want to pay less taxes! For some reason, it is widely assumed that LLCs provide more tax deductions and more loopholes than a personal tax return. Wrong! There’re no new deductions just because you organized your business as an  LLC. Whatever you can deduct with an LLC you could also deduct without LLC.

Am I saying that real estate investors cannot save on taxes with LLCs? I am not saying that. LLCs can provide tax savings under some specific situations, and these situations should be evaluated case-by-case by a competent tax professional. As a rule, LLCs cannot save money to landlords. Savings are possible for highly profitable builders, rehabbers, flippers and wholesalers. What do I call highly profitable? Let’s say those who make at least $50k net profit, after deducting all business expenses. If you reached this level of profitability, we need to talk, because the tax savings do not happen automatically. We will need to do some paperwork and establish new processes.

Keeping Your Balance: The fundamentals of tax-efficient investing

Anthony G. Sandonato for the NYDailyRecord.com writes: As prudent investors know, it is not what your investments earn, but what they earn after taxes that counts. After factoring in federal income and capital gains taxes, the alternative minimum tax, and any applicable state and local taxes, your investments’ returns in any given year may be reduced by forty percent or more. Adding to this tax bite is the relatively new 3.8 percent Medicare Tax on net investment income that impacts high-income individuals, trusts and estates.

To see the impact of taxes on investing, consider that if you earned an average seven percent rate of return annually on an investment taxed at 28 percent, your after-tax rate of return would be 5.04 percent. A $50,000 investment earning 7 percent annually would be worth $98,358 after 10 years; at 5.04 percent, it would be worth only $81,756. Reducing your tax liability is essential to building the value of your assets, especially if you are in a higher income-tax bracket. Here are several ways to potentially help lower your tax bill and grow your investments.

Invest in tax-deferred and tax-free accounts

Tax-deferred accounts include company-sponsored retirement savings accounts such as traditional 401(k) and 403(b) plans, traditional individual retirement accounts (IRAs), and annuities. Contributions to these accounts may be made on a pre-tax basis (i.e., the contributions may be tax-deductible) or on an after-tax basis (i.e., the contributions are not tax deductible.) More important, investment earnings compound tax deferred until withdrawal, typically in retirement, when you may be in a lower tax bracket. Contributions to nonqualified annuities, Roth IRAs, and Roth-style employer-sponsored savings plans are not tax deductible. Earnings that accumulate in Roth accounts can be withdrawn tax-free if you have held the account for at least five years and meet the requirements for a qualified distribution.

Withdrawals prior to age 59½ from a qualified retirement plan, IRA, Roth IRA or annuity may be subject not only to ordinary income tax, but also to an additional 10 percent federal tax penalty. In addition, early withdrawals from annuities may be subject to additional penalties charged by the issuing insurance company. Also, if you have significant investments, in addition to money you contribute to your retirement plans, consider your overall portfolio when deciding which investments to select for your tax-deferred accounts. If your effective tax rate — that is, the average percentage of income taxes you pay for the year — is higher than 15 percent, you will want to evaluate whether investments that earn most of their returns in the form of long-term capital gains might be better held outside of a tax-deferred account. That is because withdrawals from tax-deferred accounts generally will be taxed at your ordinary income tax rate, which may be higher than your long-term capital gains tax rate.

Look for tax-efficient investments

Tax-managed or tax-efficient investment accounts and mutual funds are managed in ways that can help reduce their taxable distributions. Investment managers can employ a combination of tactics, such as minimizing portfolio turnover, investing in stocks that do not pay dividends and selectively selling stocks that have become less attractive at a loss to counterbalance taxable gains elsewhere in the portfolio. In years when returns on the broader market are flat or negative, investors tend to become more aware of capital gains generated by portfolio turnover, since the resulting tax liability can offset any gain or exacerbate a negative return on the investment.

Taxes are an important consideration in selecting investments but should not be the primary concern. A portfolio manager must balance the tax consequences of selling a position that will generate a capital gain versus the relative market opportunity lost by holding a less-than-attractive investment. Some mutual funds that have low turnover also inherently carry an above-average level of undistributed capital gains. When you buy these shares, you effectively buy this undistributed tax liability.

Use tax loss harvesting to your advantage

At times, you may be able to use losses in your investment portfolio to help offset realized gains. It is a good idea to evaluate your holdings periodically to assess whether an investment still offers the long-term potential you anticipated when you purchased it.

Your realized capital losses in a given tax year must first be used to offset realized capital gains. If you have “leftover” capital losses, you can offset up to $3,000 against ordinary income. Any remainder can be carried forward to offset gains or income in future years, subject to certain limitations.

A few down periods do not mean you should sell simply to realize a loss. Stocks in particular are long-term investments subject to fluctuations. However, if your outlook on an investment has changed, you can use a loss to your advantage.

Keep good records

Keep records of purchases, sales, distributions, and dividend reinvestments so that you can properly calculate the basis of shares you own and choose the shares you sell in order to minimize your taxable gain or maximize your deductible loss.

If you overlook mutual fund dividends and capital gains distributions that you have reinvested, you may accidentally pay the tax twice — once on the distribution and again on any capital gains (or underreported loss) — when you eventually sell the shares.

Conclusion

When considering investment decisions, tax implications play an important role. While they should not be the only factor to consider, investing in a tax-efficient manner can significantly increase you returns and net worth over the course of your lifespan. 

10 Basic Tax To-Dos for the Rest of 2014

 Evan R. Guido for the Bradenton Times writes:  Here are 10 things to consider as you weigh potential tax moves between now and the end of the year.

1. Make time to plan

Effective planning requires that you have a good understanding of your current tax situation, as well as a reasonable estimate of how your circumstances might change next year. There's a real opportunity for tax savings when you can assess whether you'll be paying taxes at a lower rate in one year than in the other. So, carve out some time.

2. Defer income

Consider any opportunities you have to defer income to 2015, particularly if you think you may be in a lower tax bracket then. For example, you may be able to defer a year-end bonus or delay the collection of business debts, rents, and payments for services. Doing so may enable you to postpone payment of tax on the income until next year.

3. Accelerate deductions

You might also look for opportunities to accelerate deductions into the 2014 tax year. If you itemize deductions, making payments for deductible expenses such as medical expenses, qualifying interest, and state taxes before the end of the year, instead of paying them in early 2015, could make a difference on your 2014 return.

Note:  If you think you'll be paying taxes at a higher rate next year, consider the benefits of taking the opposite tack--looking for ways to accelerate income into 2014, and possibly postponing deductions.

4. Know your limits

If your adjusted gross income (AGI) is more than $254,200 ($305,050 if married filing jointly, $152,525 if married filing separately, $279,650 if filing as head of household), your personal and dependent exemptions may be phased out, and your itemized deductions may be limited. If your 2014 AGI puts you in this range, consider any potential limitation on itemized deductions as you weigh any moves relating to timing deductions.

5. Factor in the AMT

If you're subject to the alternative minimum tax (AMT), traditional year-end maneuvers such as deferring income and accelerating deductions can have a negative effect. Essentially a separate federal income tax system with its own rates and rules, the AMT effectively disallows a number of itemized deductions, making it a significant consideration when it comes to year-end tax planning. For example, if you're subject to the AMT in 2014, prepaying 2015 state and local taxes probably won't help your 2014 tax situation, but could hurt your 2015 bottom line. Taking the time to determine whether you may be subject to AMT before you make any year-end moves can save you from making a costly mistake.

6. Maximize retirement savings

Deductible contributions to a traditional IRA and pretax contributions to an employer-sponsored retirement plan such as a 401(k) could reduce your 2014 taxable income. Contributions to a Roth IRA (assuming you meet the income requirements) or a Roth 401(k) plan are made with after-tax dollars, so there's no immediate tax savings. But qualified distributions are completely free from federal income tax, making Roth retirement savings vehicles appealing for many.

7. Take required distributions

Once you reach age 70½, you generally must start taking required minimum distributions (RMDs) from traditional IRAs and employer-sponsored retirement plans (an exception may apply if you're still working and participating in an employer-sponsored plan). Take any distributions by the date required--the end of the year for most individuals. The penalty for failing to do so is substantial: 50% of the amount that should have been distributed.

8. Know what's changed

A host of popular tax provisions, commonly referred to as "tax extenders," expired at the end of 2013. Among the provisions that are no longer available: deducting state and local sales taxes in lieu of state and local income taxes; the above-the-line deduction for qualified higher-education expenses; qualified charitable distributions (QCDs) from IRAs; and increased business expense and "bonus" depreciation rules.

9. Stay up-to-date

It's always possible that legislation late in the year could retroactively extend some of the provisions above, or add new wrinkles--so stay informed.

10. Get help if you need it

There's a lot to think about when it comes to tax planning. That's why it often makes sense to talk to a tax professional who is able to evaluate your situation, keep you apprised of legislative changes, and help you determine if any year-end moves make sense for you.

Evan R. Guido 

www.EVANGUIDO.com