Hey guys. Toby Mathis here. And today we're going to talk about
seven mistakes people make with LLCs. all the time. I'm going to break them down
into little pieces so that you can understand what we're
talking about and give it some context. But let's just put it in kind of like
the 10,000 foot view people set up LLCs quite often for asset protection
for estate planning, for tax planning, and by setting it up incorrectly,
they undo a lot of these things that they're intending simply because
they just make pretty basic mistakes. And so let's just break down and kind of go over
seven that I see reoccurring periodically. These are fairly for non advanced people
or for the advanced people. You might say, hey,
these are pretty basic. Yeah, these are
the ones that everybody screws up. So when you go out and you try to do it
yourself, these are most common. So we're not going to even
get into the deep dove of the operating agreements
in the language that you can give up on. This is just really the low lying fruit. And the most basic number one is they put the wrong kind of income in the wrong kind of entity. So there's really breaks down
to three different types of income. I go over this all the time
and our tax and asset protection courses. There's active income, there's
portfolio income and there's passive. And they each have their own tax treatment and you get to understand
how they interact and how you can, for example,
sometimes make your passive losses, which ordinarily only offset passive income,
but how you might be able to make it non passive so it can you,
you can use it against portfolio income and your active income. And so all these things do
start to interact but you can really screw it up
by putting it in the wrong type of entity. So one of the things that I see
quite often is when people set up an LLC, they might say, Oh, I understand that,
I need to formalize my business. And they look at it and say, okay,
I know it can't be me. So I'll set up an LLC and they set up
what's called a disregarded LLC, which means the IRS ignores it,
and as a result, 100% of their income
might be active income. All of a sudden they're in a situation
where they could have reduced their taxes
considerably by filing one document. You know, let's say we make an election. This is a let's just say
it's a sole proprietorship. Let's say it's a business money and say so
ridership. It's just you and your business. It it's it's you LLC or me LLC. Right. You're setting up a business, say it's plumbing, business, pizza,
whatever it might be. Airbnb could even be the business. Right. And you have $100,000 of net
income coming in. It's what you live off of. The difference
between setting up the appropriate tax form is the difference between paying
100% of that income 100% of 100,000 as active income,
which is subject to self-employment taxes. Boom. You didn't even know that. Oops. What are self-employment taxes? Is old age, disability and survivors,
which is 12.4%. Medicare, which is 2.9%, added up. It's 15.3%. You get a slight deduction. So the math works out
to it's a 14.1% tax on that 100,000. Could I reduce that? Absolutely. By simply choosing
the right type of entity will get there. Right. But they don't understand
the type of income in the first place. So they tossed him in the
or you toss something in that's passive. Let's say you have rental income coming through and
you put it into something like an escort and your accountant's
going to get all over you saying, Hey, you need to take a salary
out of an escort view. Distribution can't be 100% when realizing
that, Hey, that's passive income. Why don't I put it into something
that's appropriate for an active entity? Plus,
if I take the property out to refi it or something like that,
that's a taxable event and an escort. Right. And you're saying as corp, he's
talking about an LLC. Time out. We're going to do this weird thing
where we talk about the LLC. Here's what the IRS sees when you say LLC,
they go like this. I have no idea what you're talking about
because there's no such thing as an LLC to the IRS, right? What they see is a
you know, there's either default, which is if it's just you,
it's a sole proprietorship or if it's more than one person,
it's a partnership. Or you could say, Hey,
treated as a corporation, but there is no tax form for an LLC
with the with the federal Government, there's no magic tax from like there
is for a corporation like your C Corp. It's 1120, right. If it's a individual
operating their business, it's just going to be a Schedule
C on their 1040. So by not knowing the type of income
you're putting in there, you could screw it up and make it taxed
that otherwise wouldn't be so. For example, passive income
is not subject to self-employment tax. If all of a sudden you have to take
a salary out, salaries are active now you have to pay the Social Security tax on self-employment
tax all the same thing, right? You're paying old age disability
and survivors and Medicare. So we don't want to force ourselves
to pay that extra tax if we can avoid it. And it's just not knowing
the type of income. So that's number one. I just say that's numero
uno is they screw up by not knowing the type of income that's going in the LLC
and they end up using an inappropriate entity for the type of activity they're doing. Numero two Right. Let's go to number two
is they set it up too late. Hey, I'm I'm going to flip a property, so I buy the property
and then I set up the LLC. Let's not do that. Let's set up
that LLC before we take title. Because if you're going to take title,
you don't want your name sitting on title. If you can avoid it. If there's a way possible to wear your name,
it does not show up in the public record with regard to that property. You go for it if it's investment property
or a flip or a business for that matter. Hey, I'm going to open up
pizza shop, right? Don't open up the pizza shop as yourself
and then incorporate it. Incorporate, then open up the pizza shop. Why do you do that? Because you're trying to isolate
the liabilities by putting it in your name opens up the door as to when that
that when that liability occurrence was. Whether you have personal exposure,
now you're in China, China title, all those things. And immediately people are going to say,
Yeah, but my bank requires if it's real real estate,
I got to close in my name. If you're flipping properties
in, you're not working with a lender that's going to allow you
to close in the entity. Look around for different lenders, right? There's so much liability that comes with
with with things like flipping that you want to make sure it's not touching
your individual name, if at all possible. And then even afterwards, I would say
this, this is so there's one and two we're on to. This would be like to a or to B,
which is shut down that entity. After you're done, you're doing something
that has a lot of liability with it. Get it done, get your money, close it down right
and move on to another one. They're not that expensive to set up,
so set them up. That's what the reason is. But their existence
is to isolate that liability. They work
well with the state plans and they you can use them for different tax
treatment. They're Swiss army knife of of taxation. But at its core it's
you're paying the state for protection. Don't undo that by not using the state
for that protection. Right. The whole idea is I use the LLC
so I'm not personally liable. So don't do stuff
and make yourself personally liable. And then when you close it down, don't
do stuff that makes you personally liable. Get rid of that entity. It's done by by give it away. That way you can ignore anything
that comes down the pike after it. Other fun things they do. They set up an LLC and they do not create
its own employer ID number. So we see that quite often. It's almost impossible to bank. Actually it is impossible the bank,
but they don't set up and create its own separateness. So if you're setting up an LLC
and you want asset protection and you want it to be treated
separately from you for estate planning or for tax planning, it's
got to have its own employer ID number. So you and I, as individuals
have Social Security numbers, businesses have an EIA and an employer ID number. If you do not give it its own Social
Security number, where does it default to? It's got two thumbs in sitting right
here. Right. It's me. I become my business. And the more that I am my business
and there's no distinction is the more likely it is that they're going to ignore it
and just look at you instead. Because if I don't respect my entity,
no court's going to respect that entity. So you have to respect that entity and
you respect it by creating its own line. And that's going to lead us
into number four, which is they don't utilize that business
as a separate business. And there's all sorts of reasons
you do that. Number one, I might be able to sell it. Number two, I might be able
to have credibility on its own. And what do I mean by credibility? Credibility
means things like banks and credit cards might give you credit
because it's a separate business. Now, a lot of times they're going to rely
there's there's three things you always look at when you're dealing with credit,
cash, collateral or credibility. If you have any one of those three things,
you're going to get credit. So you have a brand new business.
Think of it like a teenager. It doesn't have any credibility. So it better have cash or collateral. So if you're buying
real estate, there you go. I can lever the real estate. I have some collateral. Maybe it goes that way
if it needs credibility, they're going to look at you
for a little while. They might say, hey, you know what? For the first couple of years,
you got to sign off on this stuff. Maybe they use your credibility
as a guarantor on a credit card and they still report it as a business. Credit card. And eventually,
hopefully, you're no longer a guarantor. Right. You can get to that point
after you have enough credibility. If you have cash, people say, well,
what are you going to a cash? I'm going to buy a CD or put it in a CD
and then I'm going to get a line of credit against it to the business until such time
as they don't need the CD anymore. So rather than just put money in the company and say, Hey,
I put money into the LLC, right? And I funded it. Yeah, put money in the, in the LLC
so you can find it. Get a line of credit
like put that in a bank in the name of the LLC by the way,
and get a CD and allow that to be collateral
against that line of credit until such time as they
no longer need the collateral. Once you have enough credibility, they'll release that requirement,
usually two or three years. And now you have a line of credit
in your business and you can take the money back out. If you put the money back in, or sometimes
you don't have to put the money in, you can just pledge your own CD and say, Hey,
you can lean in that because there's there you go, I'm going to sign my personal CD
that's sitting there and you can use that as collateral. The bank will do the paperwork to do that
so that they know that if the business does not pay back
its line of credit, they have a CD that's covered it for security,
no different than a a lock or anything like that home equity
line of credit. They have the the that the house
that they can sell if you don't pay it. So you know, so that's number four, right? Number five is books and records,
making sure that you have actual separate books and records. Now, here's the dirty little secret. Doesn't matter whether you're an LLC, a corporation,
a partnership, or an individual. Books and records are a requirement. Whenever you're an investor activities
or business activities, there is no difference
between those entities. There's nothing this. There's more books
required for a corporation. It's all the same. You got to keep track of the income
and expenses. And keep in mind that when these requirements
came out, QuickBooks didn't exist. People used to do it on a ledger. They used to do it in pencil. Like as long as you keeping
track in your numbers, you don't care about
whether it's an Excel spreadsheet where you're keeping
track of these things. Are you using a program like QuickBooks? At the end of the day,
it's the same no matter what. And where people will screw up an LLC
is they just treat it as them. They don't create separate books for it
and they don't account for it separately, you know, and just think about this. If it's using your bank account
and your credit card and you're doing everything, doesn't
it seem like maybe the courts are going to look at this
and go, wow, there's no difference
between this person and the other? Now, there
is kind of an exception to the rule. When you're in real estate, you had a lot of properties
and they're all held by holding entity. There might not be a reason
to have the bank account. It's not something called dispositive
and it doesn't nuc your entity, but when it's you as the sole owner
and you're doing everything in your bank account,
it looks really bad and it opens up that door
for an equitable argument called piercing that you don't want to come anywhere near
if you're setting up that LLC. So how do you avoid that? You set up the LLC, right? You do like we talked about in point
number three, which is you set up the the EIA and you get a bank account
and you keep separate books. There you go. There's lots
of benefits that come along with that, but it also keeps it separate from you
so that the benefit that you paid, the state
for which is, hey, I want to make sure that I am getting asset protection
and I do that. And I want to make sure that that I get the right kind of asset
and I get the best asset protection. I want to make sure
that I'm getting everything I paid for. Don't undo it
by being lazy on these things. Keep separate books and records. So when I say records,
I mean minutes of your meetings, which just means that
if we removed you from the situation, is there a paper trail
that explains what that LLC was doing? Can we see what it decided to do
when it decided to do it? And usually there's a paper trail like in real estate,
there's always a paper trail because you're going
to have these signed documents. So there you go. You have records on it. It helps if you have minutes of a meeting
or you have notations or you have everybody
agreeing to do something. Like if you have partners, you say, Hey,
we're going to acquire this unit here. And everybody says, I agree,
that's a great idea that it does. Then you go buy it. So you have a HUD,
you have a purchase agreement, and you have these notes
that might even be in an email. Those are records. It doesn't have to be this magic. I want my minute meanings, you know,
and it has to be that all of the error
shall therefore be rules of conduct. So now if you're just a M.L.S., it's just you,
you know, it's just your business. Just make sure there's a paper trail.
So if somebody comes behind you, they could say,
What were you deciding to do? And Can we see a paper backup? Same thing with books and records. It's just making sure that there's
a record of the same thing for books. It's making sure that,
you know, here's income, here's expense. And thinking of that,
let's go to number six, which is make sure that
if you were incurring personal expenses on behalf of that LLC, that you're
adequately reimbursing yourself and you're keeping a note
of what you're reimbursing for. So for example,
if you're in real estate and you're using, you know, if you're paying contractors,
make sure that you're that that you have a record
of who you paid and why. If it's a contractor,
this will go with our next next point. But make sure that you have that W-9. If you have expenses, like,
hey, maybe you have a cell phone, maybe you're driving a car or whatever
and you're reimbursing yourself. Make sure that you either
have an accountable plan. If it's if you have an accountable plan,
this could be a corporate entity. If you don't have an accountable plan,
make sure you're documenting that it was specifically used
for that item. Like if you go out
and you buy things for a rental property and reimburses,
you say, here's what I reimburse for it. Get a copy of the receipt,
put it in there. So if there's ever a question,
they know that that money came out to you
as a reimbursement, not as income. So just make sure that you are doing that
appropriately. It's just it's just documenting. It's just as simple as a couple of notes what what it was, why it was
when it was, how much it was. Right. And make sure that that you are keeping
some sort of written record of it, even if it's on a spreadsheet
or it could be on a calendar, whatever. Just make sure that when you're reimbursing, you're explaining why it is
you're not just handing cash and then you can't remember two years,
so you get audited. They go back three years,
you get four or five years into the future and you're trying to remember what you did
five years ago. Good luck.
You got to have a written record. And then the last thing I'll say
and this kind of mirrors with that, with with point number one,
which was the types of income is make sure that you use the appropriate tax form
for the the type of LLC you're using. So if it's an LLC and it's ignored, it's
ignored, you're going to use the owners tax form, which might be your 1040. It might be that it's
going to another entity, it might be that it's going to a partnership,
for example, in which case
you're not doing a tax return for the LLC. It's all of its information. All of its books
are going to get reported. All of its income and expenses are going
to are going to get reported on its owner,
which in that case would be a partnership. So let's say you had a
a an LLC real estate holding company. Let's say you used Wyoming
because it's smart to do so. And you had a Wyoming Partnership LLC. You use a 1065 for that LLC and then it has six or seven LLC under it, owning pieces of real estate
around the country. Okay, each one of those, what does
it need to file if it's disregarded? That wouldn't have any federal filing. There might be a state,
but there's no federal filing, so there's no tax return there. It's all going to end up on that. 1065 So
you have to think of your structure and say, here's the entity structure,
but what's my tax structure look like? Do you know that I could actually set
that same scenario up? Let's say we set up a Wyoming LLC
that is owned by you disregarded
and it has 20 LLC RVs underneath it that are disregarded
and owned by that LLC. Whose tax return does that all end up on? It's you. You own the parent, you own the holding company
and the holding company owns all of this. The Sub LLC is in there, all disregarded. It means you're ignoring everything
you set up even though there's 21 LLC. It's all going on page one of
your schedule if it's real estate, right? So or, you know, whatever type of business you might have,
it might all end up on your on your 1040. You have to respect the different
tax forms. So here, I'll just go through them
real quick with you. When you have an LLC, it's
either going to be ignored, which means it goes under the owner's
tax return if there's more than one owner, it's
going to be a partnership. That's the default, which is a Form 1065. If it's a corporate entity, you're going
to be either an S Corp or C Corp. If it's an S corp
and it flows on to a return, it's going to file in
what's called an 1120 S and it's going to give each of its owners,
the shareholders, ak1 to report that income. It's kind of like,
here's the income that we made. It goes down to the shareholders,
which is the same thing that it does in a partnership. The partnership and the S Corp, the 1120
s, the 1065 and 11 taxes. They are informational only returns. You don't pay a tax with them
and that gives ak1 reporting the income and expenses
so it could be income and losses that are being reported to the owners
of that organization. So again, so it could be an S corp
and it could also be a C Corp, C Corp, 1120 C Corp's
pay their own tax. It's 21% flat right now. And that could go up and go down. It could go sideways
depending on what Congress does. Right now, it's 21%. And then if it pays out the profits that it pays tax on to the shareholders,
those are taxed as dividends. But the tax form, just to get it
out of the way is that. 1120 And then the last thing I want to focus on
is, depending on who you're paying, maybe it's paying you depending
on the entity, you might have a W2 or you might have a W-9
and or you might have a K-1. It all depends on who you're paying. If it's a contractor,
it's going to be 99% of the time. It's going to be
you're going to be doing a W9 and you're going to get them at 1099
if it's more than $600 a year. So if you have a contractors
working on properties and you pay them a thousand bucks, $2,000
for a job, you're going to want
to get a W-9 from them, which says here is what mine is
or my tax identification number. And then you are going to once a year
give them a 1099 saying here, IRS,
I paid this contractor over here. If you pay payroll,
if you're a sole proprietorship and you have nobody else working for you,
you should not be doing W-2, period. You can't do payroll of your own sole proprietorship, nor can you do
payroll on your own partnership. On the sole proprietorship,
it just goes right on your return. 100% of the net
income goes on your return. The net net loss goes on your return. If it's a partnership, you get those K
ones and it goes to the partners that you do not pay yourself via a W-2. The only time the W-2 comes in
is when you have corporations, and that's an S or a C Corp. If you are a single owner S corp,
you still pay yourself a W-2 wage depending on if you're taking money
out of the organization. And I didn't just misspeak. You don't actually have to take a W-2
out of a quartet of A. S corp if you're not making distributions
out of the SE technically,
you only pay yourself a salary if you're taking the money
out of the organization. So again, you make a $100,000 a year. You probably pay yourself a small salary,
maybe 30, 40,000, and you'd pay the rest of it as a distribution
out of the s corporate would escape the dreaded Social Security taxes. That's how you do it. You save yourself quite a bit of money
when you do things that way. And then if it's a C Corp,
you're paying yourself a W2 income. And out
of that, if if you're taking wages, sometimes you just reimbursing expenses,
sometimes they're being zeroed out. There's not a lot of money in there. They don't have to pay you. But if you're going to take money
out of that puppy, you're probably going to want to take a salary. And then if there's profits,
you're going to be taking a a dividend and you're going to be 1099 yourself
on the on the dividend, I believe it's ten 9095 year or whatnot
you're going to be giving yourself here's the dividends
that I paid out on that C Corp as well. So we just went over a bunch of tax forms. If it was too fast,
go back and listen to it again or keep digging in
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