Entity Requirements & CA Franchise Tax Board – Video
Presenter: Here’s nasty, nasty stuff that the FTB is doing say basically if you have an entity that you’re actively doing management which means telephone calls, emails, bank accounts here, writing checks, that you’re supposed to be qualified to do business here and pay taxes here. The nasty language is, if it’s a partnership and you have the possibility of managing in California because you’re a resident you owe taxes. With the Franchise Tax Board who has the burden to proof that you’re innocent?
Participant: You do.
Presenter: You do. They make the assumption and you have to prove like, “Here’s the airline tickets, here’s the hotel, here’s my ledger why I talk to the property managers, here’s when I review the properties, all those types of things. People don’t want to do that, and the Franchise Tax Board is really cracking down, so you need to be careful.
Part of your question is yes, you need to have entities and perfectly multiple entities. You may want to have an entity just to manage. Everybody remember the case down in San Jose? Where the landlord had known that the tenant below always complained about the older lady above that had the TV up way too loud. They both complained about each other. He banged the ceiling with a stick and they’d be screaming, yelling each other that went on three years. Anybody remember what happened?
Participant: They killed each other.
Presenter: He went off and killed the older lady, yes. What’s more risky owning the building or managing?
Participant: If you’re managing in California what kind of entity would you suggest?
Presenter: That’s not an easy answer to give you. Is it non California real estate?
Participant: California real estate.
Presenter: Oh, boy. I’ll give you a two-minute spill on the really nice weather tax in the state of California. Under proposition 13 when you buy a piece of property in California, how much can be assessed raw value go up for you?
Presenter: 2% or CPI, whichever is less. We actually have one year it was not 2%. How much are the property taxes constitutionally guaranteed to be? 1%. We always say one and a quarter because you’ve got the mosquito abatement districts, you’ve got the library fee, you got all these other things that add up. So, what’s prop 58?
Proposition 58 is if a piece of California property goes from the parent to the child by a sale, gift or inheritance that is not a re-accessible event under proposition 13. The keywords are, it’s a real property interest. If you have real property in an LLC full time member do everything you’re supposed to, and you give the membership units to your child. Is that personal property or real property?
Participant: It’s personal.
Presenter: It’s personal property. Different rules apply under Prop 58, change of control or 50% plus 100% gets reassessed. That’s why I said it’s not an easy answer in California. It’s an easy answer if you can tell me when you’re going to die, because a couple days before we’ll roll it out of the LLC so you own it in your name, and then it’s a real property transfer.
Participant: I just mean managing it. If you own California properties and their owned in your LLCs but if you want a separate company to manage that would you also have that in an LLC or would you have an S corp?
Presenter: No, I’d would have it as an entity itself. I’d pay W2 I’d have 401 care, I’d have a profit sharing, I’d have a defined benefit plan.
Participant: You do that as LLC instead of corporation?
Presenter: Either way, it’s whatever you’re comfortable with. Corporation you do have to have the meetings which are usually about five minutes. By the way, does everybody have meetings
for their entities, for their business? Probably every other day you have a meeting, right?
Presenter: Do I sell? Do I buy another one? Do I have adequate insurance? What do I do? You’ve had the meeting, you just don’t put it in paper. It’s not that you’re not holding meetings because you are. It’s just you’re not formalizing in paper and that what you’re required to do with Corporation, you’re not required to do with an LLC. That makes some sense? Again, if you own property like my neighbor who bought in 1948 in Los Altos, pays less than a hundred dollars a month in property taxes. He’s going to leave that to his two kids, it’s not going to be reassessed. They will continue paying the $100 a month in real property taxes.
Doesn’t end there. Forgot to tell you, they both have children also. Parents to child, parent to child, parent to child, parent to child, parent to child. Again, it’s a great asset but only for assets, a real property in the State of California.
You’re blessed own rental property here, we actually have a couple clients that bought warehouses in South San Francisco in the ’60s. Their assessed raw value is $400,000. I’m not making that up, I know their property taxes or $5,000 a year. They’re worth about $8 million.
What’s 1.25 times 8? Somebody help me, is that around 100,000? That’s what would happen if they don’t follow Prop 58. The family loses $95,000. Not only do you lose money $5,000 a year, but 2% of 400 is what? Versus 2% of 8 million, so the snowball grows. That’s only in California, only California has Prop 13. That’s part of the wealth preservation in the state of California. You’re limited to a million dollars of assessed roll value on non-primary residence.
Not fair market value, not basis, assessed roll value. Is that little letter you get ones a year, once a year that says the building’s worth this, the land is worth this. There is this really nice gift, right? The homeowner’s exemption, how much is that? It’s $7,000, they’re really generous. That’s one of the nice things about owning real property in California. They get you with a lot of other things. By the way, what are we number one in? Perfect.
Presenter: Income tax, 13.3. We are the highest tax rate for income tax. We used to be three but the voters passed the tax remember to add three more percent to themselves. Again, there’s a lot you can do, the main reasons you’re doing this for income tax purposes, for wealth transfer purposes, avoiding gift and inheritance tax. As a side, you’re getting creditor protection. If you remember, nothing else should you get up on the stand, “Oh my god. The attorney said there were so many different things. I can’t even tell you everything he said, why we’re doing this stuff” You’re going to sound a lot better than, “Oh, we did it for creditor protection” Has everybody got that down cold? Yes.
Participant: I understand the inheriting of real estate in California if it’s owned by living trust. Is that real property?
Presenter: Correct. If it’s a revocable living trust, not irrevocable trust. If it is a revocable living trust it’s still considered transfer of real property. The issue becomes like myself I have three kids, I own one home. What’s the assessor going to want to do? If one child gets the home, the other to get other things? What’s the assessor going to want to? Say it’s no longer parent to child, sibling to sibling and we’re going to reassess two thirds? You got to be really careful how you do things. That’s only California, no other state has it. If you’re investing outside California, you don’t need to worry about that. It makes it easier.
Participant: You say you have to file on the prop 58, is that what you said?
Presenter: No. What you actually do, as long as you file a homeowner’s exemption, then the assessor says that’s your primary residence and because of that then you’re allowed to use prop 58.
Participant: Then your primary residence should not be LLC because then you’re going to do it.
Presenter: No, that’s one of the fatal flaws. Would anybody put their house into an LLC for anything other than creditor protection, the courts say no. That’s the one thing that you need to leave alone. There’s nothing stopping you from getting bits and pieces of it on 1% or 2% to a child’s irrevocable trust. You can do that type of thing.
What’s the other thing that you get with entities? How do we talk about entities that you can do, I will give you a hint. Its inheritance taxes and gift taxes. If you only own 10% of a business and you try to sell that 10% to someone else and the business is worth a million dollars, is anybody going to pay $100,000 to go into business with somebody they don’t know? The answer is probably not. What do you think the IRS allows you to do?
Presenter: To take discounts on those assets, because it’s a minority interest. You don’t have control, lack of marketability, all those things. You can take 25% so you can get a discount for inheritance and gift tax purposes and or sales to children. There’s just a lot of reasons why you can do these things that don’t say wealth preservation, asset protection. You’re doing it for all these other things. If the IRS was arguing with you, what do you say? It’s for protection.
If the creditors are arguing with you, it was for tax protection. I was able to give stuff to kids over a long time period. I’m not subject to a 40% gift tax. I’m not subject to 40% inheritance tax. I’m not subject to all these things. I’m now able to keep the family wealth in one. I can do loans to the family so they can buy stuff, so my cash flow is protected. All these legitimate reasons why people do things that aren’t credit protection, and the more you have and the more frequently you do it, the better off you are.