Individual & C-Corp with rentals and flipping/constructing

[cientax]

Thanks KC for your response to the other question.

Have another client (TX) that has various rentals, buys and sells houses and also constructs houses then sells them. He has a C-Corp that he set up last year for the construction of houses then to sell them. Last year (2006) there was no activity for constructing houses.

Would there be a problem IF he were to hire and pay the C-Corp for making repairs to the rentals and expensing on Sch-E 1040; Pay the C-Corp for improving houses he buys as individual and fix up for resale and show all expenses on Sch-C 1040; and Pay the C-Corp for construction of new houses to sell also Sch-C 1040. Income received from the activities to be reported on the appropriate schedules on 1040, pay the C-Corp for repairs, fix up, and construction then pay salaries/wages from the C-Corp with expenses for materials. He is sole shareholder in C-Corp. Not putting any of the properties in the C-Corp.

He's not trying to hide anything, he just wants to pay himself a salary with the employment taxes paid. I think that he should not pay the C-Corp for the Sch-E activity since there may be additional employment taxes where there is no SE Tax from this activity.

Any opinions? Thanks

[OldJack]

I don't see a big problem with the concept of the C-corp, however, the detail of the transactions could easily cause a problem if the transactions are not at arms length. It could easily be argued that he was controlling profit on the 1040 with transactions designed to limit or shift income for no other purpose other than avoiding taxes.

I question the business purpose of the C-corp when it is only doing business with the single related shareholder. The only benefit I see in a C-corp of this activity is maybe tax-free benefits and shifting income to lower tax brackets or averaging the brackets between the corp and the 1040. That could be an obvious consideration for audit and reclassification of income. This would probably not be a question if it was a pass-through S-corp.

[cientax]

I don't see a big problem with the concept of the C-corp, however, the detail of the transactions could easily cause a problem if the transactions are not at arms length. It could easily be argued that he was controlling profit on the 1040 with transactions designed to limit or shift income for no other purpose other than avoiding taxes.

I question the business purpose of the C-corp when it is only doing business with the single related shareholder. The only benefit I see in a C-corp of this activity is maybe tax-free benefits and shifting income to lower tax brackets or averaging the brackets between the corp and the 1040. That could be an obvious consideration for audit and reclassification of income. This would probably not be a question if it was a pass-through S-corp.

Would you then suggest that he make the S-Corp election to have it flow back through to the 1040 as ordinary income? He set up the corp so that he could operate his construction business and plans to build houses not only for his personal business purposes but also to build for other individuals and he's wanting to keep the construction business aspect separate from the rental activity.

[OldJack]

Oh... If he is doing construction work for others with the corporation, then its not quite the problem. However, related transactions are still a question if he is shifting income to avoid taxes. A C-corp can be a good way to save taxes if it is a long-term operation where the main reason is to average tax rate brackets with the 1040 income or to sell the corporation stock at a later date to cash-out at capital gains rates. There are a lot of disadvantages to a C-corp such as the old double tax effect if you have to pay non-deductible but taxable dividends. Also, the problem with possible "personal service corp" status and tax where most of the income is generated by the owner in certain field such as consulting.

I would expect that to start with your client might be better off electing S-corp status. You should review his situation with publications such as the Small Business Quickfinder Handbook, tab M, "Starting a new business", and the business entity comparison charts starting on page M-2.