I would like to setup a business structure, where I can buy/sell dividend and income bearing stocks/ETFs/funds and use the income as "revenue", while deducting expenses such as health premiums, health expenses, miscellaneous home office expenses, and retirement contributions. I also want the resulting business to make my wife and I eligible for group small business health insurance. Finally, I want the assets of the business to remain in the joint revocable trust my wife and I have set up. What is the best structure to achieve this? Note, the income from this business will be my only source of income, and I want to avoid double taxation on that income. There will be no employees, except myself and my wife.
The likely best entity for accumulating portfolio income and deducting fringe benefits is a C corporation.
"10. When can a C corporation be recommended?
The following are the three most advantageous situations:
* There is a need to reinvest profits for reasons such as capital expansion. Limited income splitting can occur, resulting in the C corporation obtaining the benefit of the 15% and 25% tax brackets on the first $75,000 of taxable income.
In addition, there is the availability of excluding 70% of the dividend income of publicly-traded stocks as a result of the dividends received deduction. This is beneficial for nonappreciating securities being held for investment by the corporation (e.g., preferred stock).
* The full deductibility of the type of fringe benefits (principally health insurance including dental, optical, and long-term care or nursing home coverage) is not available to the owners of partnerships, S corporations, and LLCs having more than a two percent interest.
* A corporation formed in a state without a corporate income tax (e.g., Nevada) can be funded with money and assets in order to lend (in a secured manner) or lease to a corporation in a state where business operations are being conducted. This can reduce the corporate income taxes in the latter state by shifting income in the form of deductions such as interest and lease payments, or perhaps royalties and licensing fees, to the corporation in the state without taxation.
This strategy can be utilized provided a bona fide corporate office presence exists in the tax-free state (e.g. a Nevada corporate resident agent headquartered in Carson City). Though the implications of any applicable unitary tax must be considered, Federal law prohibits states from taxing interstate commerce when activity (such as from the corporation formed in the tax-free state) is limited in the high tax state to such activities as the solicitation of orders. This concept was expanded in 1992 by the U.S. Supreme Court case Wisconsin Department of Revenue vs. Wrigley, in which the Court ruled that "solicitation" includes ancillary activities such as recruiting, training, and evaluating an in-state sales force."
Especially in regard to your desire to be eligible for and able to deduct group health insurance the C corporation is the only entity. Owners of partnerships, S corporations, and LLCs having more than a two percent interest are not permitted to deduct fringe benefits in the same manner as C corporation employees.
Likely the best arrangement for office expenses would be an accountable plan to reimburse the employee for the business use of the home (and other expenses).
Having the assets remain in the revocable trust is problematic as the entity has to be the owner of the assets in order to claim the income from the assets. The trust is a separate entity and ownership does have to transfer to the entity as the income can not be assigned from the trust owner to the entity.
This goal is not compatible with an entity that owns the assets and has income for tax purposes from those assets.
Although the provisions of the trust would have to be examined and adhered to there may be a possibility of having an entity (such as a C corporation) be paid fees from the trust to manage the assets of the trust and retain asset ownership by the trust along with the deductions by the corporation. Issues relating to registration and security laws would need to be checked to ensure the entity, or the employees, need not be subject to licensing or other regulation as a manager of investments.
An arrangement that I have seen used for family assets is a limited partnership with the individuals (along with others such as children and grandchildren) as limited partners and a corporation as the general partner. The corporation is wholly owned by the grantor parent and the health insurance is paid by that corporation. There is not much difference in using an S corporation or C corporation for that purpose in my experience. This structure can be effectively used to gift partnership interests to the child and grandchild partners each year up to the annual gift exclusion.
Hopefully this provides some possible choices for structure that you can discuss with your tax practitioner that can advise, with all the facts, what may be best in your case.
Please ask if you need more discussion or clarification.
Thanks for your answer. If I understand it correctly, I can minimize the double taxation by keeping assets and resulting dividend income to a small amount above the total deductions allowed, further cushioned by being able to shelter 70% of the dividend income from taxation. I am not interested in the Nevada complexity. Are the dividends from the C corp to me treated as qualified dividends? If so, the main downsides are not keeping assets in the trust, but I can get around that if the shares in the C corp can be in the trust? The other downsides are the cost of setting it up and the state annual license/tax as well as the cost/hassle of making my wife and I employees in the C corp for the purposes of getting corp insurance. Just for completeness, my understanding is that as a sole proprietor business, hiring my wife as an employee, my business can pay for my wife (and her dependent husband - me) individual health plan premiums and deductible/co-payments and deduct those costs under a Section 105 HRA. Is this not true? If true, can I set my investment business up as a sole proprietorship business?
Are the dividends from the C corp to me treated as qualified dividends?
Since this is not a foreign corporation and if the holding period is met then so long as the dividend is not "of the type listed later under Dividends that are not qualified dividends " they will be qualified dividends.
Yes, these can be qualified dividends when not in those excepted types.
If so, the main downsides are not keeping assets in the trust, but I can get around that if the shares in the C corp can be in the trust?
Presumably the trust agreement is written such that the shares could be held by the trust. There is no general rule that would prohibit such ownership so only trust restrictions would prevent such ownership.
...as a sole proprietor business, hiring my wife as an employee, my business can pay for my wife (and her dependent husband - me) individual health plan premiums and deductible/co-payments and deduct those costs under a Section 105 HRA. Is this not true?
This is true.
If true, can I set my investment business up as a sole proprietorship business?
No, individual investor (as contrasted with a trader) is not in a trade or business.
For more on investor versus trader see http://www.irs.gov/taxtopics/tc429.html
"To be engaged in business as a trader in securities, you must meet all of the following conditions:
The following facts and circumstances should be considered in determining if your activity is a securities trading business:
If the nature of your trading activities does not qualify as a business, you are considered an investor..."
From your description your activity ("buy/sell dividend and income bearing stocks/ETFs/funds" would not qualify as a trade or business for tax purposes.
Indeed you need to consider the cost (time, trouble, and expense) of using any such structure against the benefit in your circumstance. Besides payroll implementation and taxes there will be additional income tax returns for the corporation. For example, in California there is often a minimum annual franchise tax due.
Hope this clarifies for you in order to consult a local tax practitioner with all the facts.
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