Ask your accountant, and they'll tell you "It depends."

Ask your attorney, and you'll get a novel of an email and a $1,000 invoice.

But all you really want is someone to tell you how to set up your business to get started without stepping on a landmine. 💥

If you feel this, today is your day. We're going into the structure I advise in a lot of entity structuring and planning calls I have (if you want one customized, just reply to this email to get set-up).

This design includes the best parts of all three passthrough entity structures and can add 10-15% ANNUAL post-tax efficiency 💰 to an investment when executed.

Let's go 🚀

Who This Works Best For

The basis of tax structuring is identifying a few driving factors:

• 🔀 Income streams - how is this venture really going to make money
• 👨‍👨‍👦‍👦 Capitalization - how is this venture going to be financed? Cash flow? Equity from investors? Debt?
• 🏭 Balance Sheet - what will the balance sheet look like? Is this CAPEX heavy?
• 🫡 Exit - what does the exit look like?

Many times, a S-Corp will be sufficient for a lot of side hustle start-ups because they only have one income stream, will cash flow any purchase needs (no debt), and any exit will be a purchase of client lists or similar.

But for those businesses that will require debt, outside investors, a heavy balance sheet, and have multiple income streams, the above structure captures a lot of the tax leakage.

Examples for who this works for: real estate syndicators (raise investor money and debt to buy a building), CAPEX-heavy SMBs that will use investor debt and equity, SBA loan-financed purchases.

Let's get into it.

AssetCo - Partnership

We prefer partnerships to hold appreciating assets subject to debt and with outside investors who will be passive. Think PropCos (property level entities) with limited partners (LPs).

Three reasons we like partnerships over S-Corps:

1. Flexibility in distributions - 1031s via TICs (tenancy in common), re-capitalizations and step-up in basis both remain possible with a partnership. 🧘‍♂️
2. Increase in basis for losses and distributions - a partnership increases your basis by the debt that is either guaranteed by you or which is qualified non-recourse (real estate specific). That means higher tax efficiency for losses generated by the AssetCo and non-taxable distributions. ⬆️
3. Flexibility in income and loss allocations - unlike S-Corps, partnerships allow for more creativity in investor returns. Specifically, a promote or carried interest that can be earned by the sponsor / GP / syndicator is eligible for capital gain treatment. This layer of return is not eligible for S-Corps. 🔄

ManagementCo - S-Corp

Here, we isolate unique income streams. The GP or operator is due separate fees for their work in running the business. This is outside of the promote or carried interest mentioned above. This income represents more like management fee income but can also include asset management fees, development fees, and acquisition fees.

We want to run those fees, when they are large and recurring enough, through a S-Corp for two ✌️ reasons:

1. Qualified Business Income Deductions - many times if these fees are paid directly to the operator or to another partnership, the beneficiaries can lose out on serious QBI deductions because there is no way to increase QBI "base" (e.g. W2 salary) to increase the otherwise allowable deduction. A S-Corp allows for this extra layer of tax efficiency.
2. Self-employment Tax - even after considering a reasonable salary to the owner, a S-Corp can save on self employment tax on the fees otherwise paid to the operator directly. That is 15.3% up to $176k and 3.8% on anything over $250k. This can easily add up to $10k-$12k in savings a year. 🤑

At the risk of repeating myself, we RARELY want to put real property and appreciating assets subject to debt inside of a S-Corp. 🙅‍♂️ If you insist on DIYing a set up before getting professional help, your #1 rule is Don't F*** It Up. And putting real estate and assets subject to debt inside a S-Corp is a good way to violate that rule.

Co-invest - Disregarded Entity

If you as the operator / GP / syndicator are contributing your own capital to the property / business that is subject to debt, you want to hold this in your personal name or through a disregarded entity.

You do not want to hold your interests in the partnership through your S-Corp unless otherwise given the okay. 🔍

The primary driver of this is to protect the debt basis from the partnership. Owning your equity investment / co-investment through the S-Corp / MgtCo undoes that debt basis. Meaning, if losses are financed through debt (think bonus depreciation), you want to be able to use those without running into basis limitations that S-Corps have.

The Bottom Line

This isn't for everyone - you need a certain level of complexity in your venture to need this. But it can save you hundreds in thousands in tax over the lifetime of your business - especially if you're doing it more than once.

Your takeaway today should be to think about the primary drivers of tax structuring and apply them to your business set-up:

• Income streams - how is this venture really going to make money
• Capitalization - how is this venture going to be financed? Cash flow? Equity from investors? Debt?
• Balance Sheet - what will the balance sheet look like? Is this CAPEX heavy?
• Exit - what does the exit look like?

Want to watch a breakdown instead? Check it out on YouTube:

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