Maybe you started by buying the building your company operates out of. You put it under its own LLC. Then a competitor wanted to retire, so you formed a new entity and bought them out. Then, you set up a management company to run payroll and back-office admin for all three.
Each decision made sense in isolation.
But then tax season came, and you noticed some problems. Good problems, mind you, but problems nonetheless.
K-1s came one at a time, some in March, others in September, so your personal return went on extension while you waited. And when the last one landed, and you could finally file, the tax bill was bigger than anyone predicted, because nobody was doing the math to predict it.
If that sounds familiar, this article is for you.
Pass-Through Ownership Is Personal
For a C corp shareholder, a bad year at the company is the company’s problem. But for partners, LLC, or S corp owners, income flows through to individual returns; every entity’s results are part of one personal return, at one set of personal rates.
And consequences follow.
For one, rules interact at the owner level. Many limits are applied to you personally, rather than the individual entity you’re managing. How much of a loss can you deduct? How do you strategically aggregate your QBI deduction across multiple entities? Decisions that look neutral when applied to one entity can interact negatively across your portfolio.
You can also owe taxes on profit you never received. Pass-through owners are taxed on profit whether or not it’s distributed. If a partnership retains earnings to pay down debt, you’re still on the hook for the phantom earnings.
Maintaining separate corporate veils is also a headache. Keeping liability protection intact means separate accounts, separate leases, separate service agreements, and separate books. It’s easy to commingle funds, but doing so could cost you later.
Growing Pains
When most businesses take off, their owners find value in handing off complex or tedious financial management to a CPA and/or bookkeeper. Their fees are certainly worth the time and headaches they save, and with their help, you get to focus on growth rather than burying your head in spreadsheets and month-end closes.
However, those experts aren’t providing tax planning services. They’re taking care of headaches, but they’re not asking “is this set up in a way that minimizes what my client owes?”
That’s not as much of a problem when your business is new. But once you’ve expanded to $2M or more in revenue, and a commensurate level of profit, it’s worthwhile to add tax and entity planning to the mix.
Where Tax Savings (and Value Adds) Come From
A properly designed multi-entity setup can save you money in surprising ways. Here are just a handful:
Entity selection and organizational structure: S corp owners are paid in two ways: salary, which carries payroll tax obligations, and distributions, which don’t. That creates opportunity, if done correctly. There’s a cost benefit analysis to do, but in general, if your LLC profits over $100,000, it’s worth paying someone else to handle the administrative hassle of switching over.
A unified financial picture: Maintaining separate corporate veils means multiple bank accounts, sets of books, and distinct revenue projections. Having someone to untangle the numbers and show you a unified picture is a valuable planning tool.
QBI deduction optimization: The qualified business income deduction lets pass-through owners knock up to 20% off their business profit before it’s taxed. Make $500k? You might only pay tax on the first $400k. The catch is there’s a cap, and it’s tied to how much a business pays its employees, and there’s a right and wrong way to structure the solution.
Intercompany transactions and related-party accounting: Entities can shift income to reduce overall tax liabilities, with higher-taxed entities transferring income to those with lower rates. It’s considerably easier said than done, though, and best left to an expert.
Asset protection: Separating assets into distinct entities safeguards against liabilities. If something goes wrong with one business, a proper setup protects one entity’s assets against another’s loss.
There are at least a dozen more optimization strategies that might apply to your situation. The key is it’s possible to create a comprehensive plan that simplifies complexity, provides a consolidated view across all your business entities, and delivers tax-saving strategies that maximize after-tax wealth.
Real World Scenario: How A Simple Oversight Can Cost $22,000 Dollars
Dan owns 100% of two S corps, earns well over $500,000 per year, and like most everyone, wants to maximize his tax deductions.
The qualified business income (QBI) deduction is a great tool for that. It allows pass-through businesses to deduct 20% of profits, subject to restrictions. Those restrictions apply to Dan because he earns enough, so each of his businesses may deduct only the lesser of 20% of profit or 50% of wages paid to employees.
- GreenLine Landscaping: Profits $500,000 annually, mostly through subcontractors installing Dan’s designs. W-2 wages are just $80,000.
- GreenLine Maintenance: Dan pays his employees roughly $600,000 per year, but his profit is just $100,000.
Counted separately, Dan’s maximum QBI deduction is just $60,000. The math works against him. However, if he counts his two companies together, the maximum deduction doubles to $120,000. That works out to about $22,000 in federal tax savings every year, all from a simple voluntary election.
But as easy as this sounds to fix (all you have to do is tell the IRS you want to aggregate), thousands of business owners overpay, every year, because nobody told them they could.
Dan’s income didn’t change. His businesses didn’t change. All that changed is the strategy of how that income got reported to the IRS. And this is just one way a multi-entity tax strategy could save Dan, or you, money.
An Advisor Who Sees the Whole Picture
Successful multi-entity business owners already have competent help. Their bookkeepers are accurate, and their CPAs put together fantastic, timely financial reports for stakeholders.
But what’s often missing is someone looking at the whole picture.
So if your businesses are siloed and nobody is planning your tax bill as a whole, a valuable conversation is just a click away. Sign up here for a free consultation.
We’ll handle the finances, you focus on growth.
