In episode 62 of How Tax Works, Matt Foreman analyzes the kinds of things that tax lawyers overhear that are often misunderstandings of tax law, and how to think about answering questions about them, as clients often ask similar questions.

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How Tax Works, hosted by FRB Partner Matthew E. Foreman, Esq., LL.M., delves into the intricacies of taxation, breaking down complex concepts for a clearer understanding of how tax laws impact your financial decisions. Through this, listeners are treated to a comprehensive breakdown of entity structures, from the robust shield of C corporations to the flexibility of partnerships and LLCs. Foreman navigates through the maze of tax considerations, shedding light on entity-level taxation, shareholder responsibilities, and nuanced tax strategies. Foreman shares valuable insights and practical advice, emphasizing the need for informed decision-making and consultation with tax professionals. From qualified small business stock to state and local tax considerations, no stone is left unturned in this illuminating exploration of tax law and entity selection.

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Transcript:

**This transcript has been prepared automatically by AI and may contain inaccuracies**

Matt Foreman [00:00:11]:
Hello and welcome to the 62nd episode of How Tax Works. I’m Matt Foreman. In this episode, I’m going to talk about comments tax lawyers overhear while on vacation. How Tax Works is meant for informational and entertainment purposes only. This may be attorney advertising and it is not legal advice. Please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business decisions that we all make. Before we get started, let’s go through administrative things.

Matt Foreman [00:00:43]:
New episodes every 2 weeks. Next episode, I’m going to talk about the taxation of influencers and content creators. It’s really the deductions they take. Are more interesting. There was a recent tax court case that, that was really, I mean, kind of a case of first impression in a way, but it was extremely in line with the advice I’d given to, to people. So I was actually really, really happy to, to read that. The taxpayer lost, but I would have politely but forcefully suggested that, that they take the position that they kind of ended up in, but, you know, without penalties and interest. If you have any questions, comments, or constructive criticism, you can email me my FRB email address.

Matt Foreman [00:01:23]:
And I have upcoming webinars. I have 6, 1, 2, 3, 4, 5, 6 starting in November. They’re Tuesdays, 1 o’clock, first 3 weeks in November, first 2 weeks in December. Free CLE, CPE for CPAs, CE for EAs, and CPE for CFPs. Some of them are still pending ’cause I still have to send them the deck so they get approved. But they’ll be approved. I have a lot of confidence, although I’m probably legally required to say that they are still pending. The topics: passive activity losses under Section 469, selling a business, tax and non-tax, SORO Bond Capital Partners and payroll taxes, Opportunity Zones 2.0.

Matt Foreman [00:01:58]:
2.0 is going to be a really good one. I have a client’s GC on that one, so it should be good. QSBS update, be the 4 trillionth time I talk about QSBS, and equity incentives, you know, grants and options and swaptions and ISOs and profits, interest, and all kinds of fun stuff. We are not actually gonna talk about swaptions, although that is an actual term and does exist, but it’s in the financial products. It’s not something you grant to employees, so it’s not an equity incentive. Anyway, so let’s talk about the taxation of influence— excuse me, talk about comments that tax lawyers overhear while on Vacation. So, so this is a quasi-continuation of a prior episode, which is questions that tax lawyers get at weddings. In that, I discussed the job.

Matt Foreman [00:02:51]:
It was episode 16. I just looked it up. You hear me clicking? That’s cool. That’s fine. But I, you know, look, I don’t really tell people what I do for a living because invariably I get questions. And there was actually a really good— Someone sent it to me because they know I do this. But it was a thing and it was the US Open tennis players, Frances Tiafoe and Jessica Pegula wasn’t on it. Although if you Google her, you know, her father owns the Buffalo Bills.

Matt Foreman [00:03:15]:
So I suspect she might get fewer questions than most. But the woman she beat, no, the one that Coco Gauff beat, I can’t think of her name. She’s like really young. I think she’s still a teen. It blows my mind that people can be top level ranked, top level professional athletes in their teens. That blows my mind. I was so far from that anyway, not that I’m any closer to being a professional athlete, but, and they ask, you know, what they tell people do and they’re like, oh, I’m just a, you know, I’m a content creator, I’m an influencer or whatever. Anyway, so I, this one came because, you know, where that one is like I’m at weddings.

Matt Foreman [00:03:47]:
This one came because I was sitting, I was on vacation with, with niece and nephew, you know, some family. And I was watching my niece jump into a pool again and again. If you’ve ever been with, you know, small children. Yeah. there’s some incredible amount of joy of someone else watching them jump into a pool and tell them how great of a job they did. And, you know, before you think I was like thinking about other things and daydreaming, A, I was paying attention to her, and B, she had water wings, so we’re good. She was all right. And I overheard someone say, you got to get it out.

Matt Foreman [00:04:18]:
I’m probably paraphrasing, but you got to get an LLC so you can deduct your expenses. And like, Man, like that was a comment, you know? So I thought about it. I’m like, actually, this would be a pretty funny episode, right? You know, sort of similarly, like things you overhear. So question 1, do you need an LLC to maximize your deductions? And the answer is very clearly no. You’ll notice I paused. And I paused because I was trying to think of any way I could say yes, maybe, but the answer is no. I hear it all the time. And it just, I don’t, I don’t even know how to rationalize it because it really doesn’t come from anything.

Matt Foreman [00:04:55]:
There is no requirement that you have any sort of entity in order to get more deductions. Furthermore, simply having an entity is a disregarded entity. It’s not reported for tax purposes. So it’s still on Schedule C. So it’s the exact same way it would be otherwise. It really is. And so I think that it’s fairly important to understand that you really don’t. I have looked for something that would suggest That having an entity would increase your ability to deduct things or anything like that.

Matt Foreman [00:05:23]:
It, having an entity is suggestive on an extremely low level that you are taking your business seriously. So it is really a business and not just a hobby. So you do have a hobby loss issue there, right? However, there’s nothing. And people say, oh, you know, if you have an entity, you know, then, then, then, you know, the, the, you’re less likely to get audited. I don’t think that’s true. I just think the people who don’t have entities are less likely to be taking it seriously as a business. If, if, if anything, you know, having, having an entity might help you get the PTET, but you need 2 owners or regarded entity, which is why you have the PTET. So the question becomes, do you need an LLC to maximize your deduction? And the answer is, waiting for the drum roll, no.

Matt Foreman [00:06:07]:
It really doesn’t matter at all. This, this comments one. The comment is one that I hear all the time, and I don’t— I’ve looked for like case law guidance, regulations, regulatory guidance, anything, anything. And the answer is no, it doesn’t exist. Having an entity may be suggestive that it’s a business and not a hobby. So theoretically, maybe a little bit on the very tiny one, but you know, it’s— you’re still dealing with some unicorn pixie magical dust. You know, if you have an entity, it might help you with a PTET. So it might lower your overall tax, you know, if you’re a regarded entity.

Matt Foreman [00:06:41]:
But you maybe don’t want to be an S corp for like a side hustle because that kind of locks you in, you know, and that could be the issue, especially if you’re one owner. There’s also QBI, you know, Section 199 Cap A. But again, you need an entity and that leads to other things. And so like if it’s, you’re worried about maximizing your deduction and you don’t really maybe have a real business, maybe not, maybe not. I don’t know. And I thought that was a really interesting one. You know, I hear it a lot as a question. I overheard it and I was like, oh, Be a funny podcast, right? Question 2, right? You should, your statement 2, whatever, you should quit your job and have them hire you back as a contractor because contractors get taxed lower.

Matt Foreman [00:07:17]:
I actually overheard this while walking through Central Park. I think I was getting a drink or something at, you know, one of the vendors. Maybe, maybe, right? Contractors can deduct expenses. They get 199K and QBI, which is QBI. They can get PTETs. So maybe, maybe it’s a little lower, but no, you know, you have to have your own health insurance. You don’t get 401 match. You don’t pay— you’re paying all of your payroll taxes.

Matt Foreman [00:07:42]:
You have to gross up the amount and you don’t get W-2 withholding. You’re doing the withholding yourself. So are you taxed less? Yeah, maybe, probably. Is it enough to give up sort of the benefits of having someone else do a whole lot of stuff for you? Probably not. You know, probably not. You know, some people do it at higher levels. They want to work for a lot of people. But I hate to say this, as I tell people, is if you form— if you just come back as a contractor and you do the exact same job before, you’re still a W-2 employee, really.

Matt Foreman [00:08:12]:
You should be. You’re mischaracterized. So now you’ve successfully made it so your, your biz— the business that employs you has tax risk for mischaracterization and could be in problem— could be in trouble upon audit. So maybe not. Question 3, right? Buy real estate and get a cost segregation study to offset your income from your job. The income from your job. Listen, these people do not— who say this do not listen to my podcast. Section 469 passive activity loss rules, one of the webinars I have coming up, will generally limit this unless you spend enough time.

Matt Foreman [00:08:44]:
Generally speaking, 500 hours in a single year, right? Might be 100, but generally 500 in a single year. Furthermore, the amount of deductions you can get is limited at about a little over $300,000. I think it’s like $315,000 or something like that if you’re filing separately or single, and it’s like $600,000-something if you’re jointly. So it can cap the amount of deduction from one to be offset by another, offset by other income. And it’s creating a significant audit risk by doing this. Oh, well, you know, this is what everyone does. And that Great. You know, if everyone were jumping off the Brooklyn Bridge, would you? And the answer is, of course, yes.

Matt Foreman [00:09:21]:
Anytime anyone asks that question, the answer is yes, because it’s a not nice question to ask someone. But I think what’s really important is, okay, you’re getting it, but eventually you’ll just get depreciation recapture. You’re going to get it back. And a lot of these real estate purchases, like to save taxes, have really bad ROIs. I had one involving solar panels. And I ran the number and cost-affected it at about a 6% interest rate, which isn’t really that ridiculously high. And it was about a 2% IRR. And if you’re getting a 2% IRR on something, you should just take the tax.

Matt Foreman [00:09:56]:
You should just take the money, pay the tax, and then buy munis because that’ll give you about a 5% IRR. So if you can’t beat munis, don’t. And the tax is better that way anyway. Yeah, so that’s a good one. So let’s get some music. And then I have, uh, I have one more. I really have one more. This is a shorter episode, and I apologize for that, but that’s cool.

Matt Foreman [00:10:16]:
I’m fine with it. So we’re gonna, we’re gonna do that. So let’s get some music in, and then we’ll come back. So this is the one that I’m going to talk about for a little while, and it’s one that I overhear a lot. My, my father has sort of said this to me. He’s like, oh, you know, this is a problem. And I’m just like, it’s not a problem. It’s not a problem.

Matt Foreman [00:11:02]:
It’s not. You need to worry about the estate tax. You know, they’re going to take everything from you. You know, you need to make sure to have your will perfect or else the government just takes the money. And like, no is my answer, right? The federal exemption is $15 million for someone who’s not married and $30 million if you’re married because there’s 2 people, right? So $15 plus $15, right? Do the math. That is a lot of money. Let’s, let’s be candid here. That’s a lot of money.

Matt Foreman [00:11:29]:
Anyone says, oh, $15 million, like, what’s the point? I don’t— um, it’s $15 million bucks. That’s a lot of money, you know, and that’s tax-free. Above that, you’re only getting taxed. It’s not like they’re taking it dollar for dollar. They’re taking a small portion of it. That’s a lie. They’re taking 40%. That’s not a small portion, but it’s less than half.

Matt Foreman [00:11:47]:
So if you had $100 million between 2 people, first $30 million isn’t taxed. The next $70 million is taxed at 40%. That’s $28 million. So you started with $100 million and ended with $72 million. Cool. That’s fine. That’s like effectively the same rate as capital gains. So it’s pretty, pretty good.

Matt Foreman [00:12:05]:
Really not, not that bad in my view. Maybe I’m wrong, whatever. Plus most states don’t actually have an estate tax that wouldn’t add into it. Some states have what’s called an inheritance tax. Pennsylvania has one, for example, has some rates for different things. New York’s one, you know, generally $7 million. Right, for residents. It has this weird cliff thing that if you go over the $7 million, it’s like $7.3 million, something like that.

Matt Foreman [00:12:29]:
It drops back to about $1 million. So you got to watch out for it. But look, like the rate’s like 11%, 16%. It’s not a monster, monster rate. And that’s it, you know, with some fairly basic estate planning. New York doesn’t have a gift tax. For example, if you do some gifting during your life, like the money’s gone. That’s it.

Matt Foreman [00:12:49]:
It’s out of your estate because you don’t have it anymore. You know, spend it, right? What’s the— you can’t, you know, go into this is, you know, you’re not an Egyptian pharaoh, you know, being buried with your wealth. It seems like it didn’t really help him. Maybe it did in the afterlife. Haven’t been there, so I don’t know. But, you know, maybe spend it, right? Even Massachusetts, which has one of the lower pure exclusion levels, is like $2 million. So I think it’s really important. A fairly basic, fairly easy life, you know, lifetime gifting plan can really get you below.

Matt Foreman [00:13:22]:
Some basic trusts can allow you to have access to it, or if you really need it, you know, you can do it for health and things like that. There’s a way to do it. Not that hard. Also, like the big thing, and this is not a tax thing, but like, like, oh, if you don’t, you know, if you don’t have a will, the state will take your money. The government takes your money. Is that what you want? And that’s actually— That’s kind of not true. All right, it’s not entirely false. If what will happen is the state, because states deal with administration, will try to find your heirs.

Matt Foreman [00:13:51]:
There are courts for that. New York State’s called the Surrogate’s Court. There’s some called like the Orphan’s Court that deals with it. They will try to find it. And, and, you know, I, I took a trust and estates class in undergrad that was taught by someone who is now the surrogate, which is the judge, uh, in The Surrogate’s Court judge in Rensselaer County, Judge— it might be Justice. I, I don’t remember. New York State’s names are weird. Uh, Paul Morgan, Paul V.

Matt Foreman [00:14:15]:
Morgan Jr. If anyone took any class with him, uh, at SUNY Albany or Albany Law, you’ll know him. He’s a really driven, great professor. He’ll, they’ll, they spend time. That’s what they do. They look for your heirs. If they can’t find it, then they find someone and they go through what’s called administration. And estate administration is basically probate, but it’s when you don’t have a will.

Matt Foreman [00:14:33]:
So that there is a process for it that does in fact happen. And I think that’s really important. If you have a will, you still have to go through basically the same process. It’s a lot easier because it says who it goes to. So I’m going to strongly, politely but strongly recommend that everyone has a will. But it’s really important that people are like, oh, if you don’t have a will, you know, do you want the government to take your money? And it’s like, well, that’s not what happens, you know, really. So I don’t think that’s a viable thing. But a lot of the people who say stuff like this also A death tax, which doesn’t exist because it’s an estate or inheritance tax.

Matt Foreman [00:15:05]:
The name of a tax is the triggering event— excuse me, is what it’s imposed on, not the triggering event. Otherwise, income taxes would largely be called sales taxes, and sales taxes would be called sales taxes, which would be super fun to deal with. And so that’s just not it. That’s just not it. I just want to point out, and this is where I’m going to kind of bring it on home, like I said, shorter one. Estate administration and estate probate is slow and expensive. So it will happen, it’ll just take a while. It won’t be as fast as you want.

Matt Foreman [00:15:36]:
So when people say, oh, you know, they’re going to take your money, they’re going to do this, well, no, they won’t. But they may burn a lot of it going through it. So that’s why I tell people, you know, who have certain assets, either make it so there’s a title holder after, you know, financial accounts, you can do that, put them in a trust so the trust itself is what operates to distribute your asset, pass it along to whomever you want. You know, that can be really helpful, especially for real property and things that have to be retitled, especially when— and this is a piece of fairly simple advice I give. Again, I’m not your attorney. This is not legal advice, but here we are— is if you have a piece of real property that you want to be sold immediately after, put it in a very basic, very simple, very uninteresting grantor trust. Then after you pass, the grantor trust will sell the property and distribute it, okay. You don’t have to wait to open probate to sell the property.

Matt Foreman [00:16:34]:
If you do and the estate is the seller, you will likely get less because it’s waited, it sat for a while, you have to sell it kind of quickly. This way it’ll give you the time to sell it in due course, so that can be really helpful. That’s it. You know, I overhear stuff tax comments all the time. The LLC one is like all the time. And people ask me the question, like, should I get an LLC? You can, you know, New York State has a publication requirement, which costs money. California, it’s $800 a year for that LLC. Most states have minimum taxes.

Matt Foreman [00:17:06]:
You know, they’re not that bad until you have 34 LLCs and you’re paying, you know, a couple grand and you’re like, why? So let’s, let’s consolidate that. Plus moving stuff in and out of LLCs can have transfer tax consequences. Or can cause revaluation for like, you know, in California, moving stuff out of a disregarded LLC to another LLC can actually cause revaluation under Proposition— what is it? Prop 19, I think it is. So it can be problematic and there can be issues. So I don’t really recommend doing a lot of things, you know, don’t, don’t overuse entities. That can be, that can be trouble. All right. So that was the 62nd episode of How Tax Works.

Matt Foreman [00:17:42]:
Also sticking with Mark McGuire there. Hope you learned something. I’ll be back in 2 weeks with the 63rd episode. I’m gonna go with Sammy Sosa on that one. And that one is taxation. We’re gonna talk about the taxation of influencers and content creators. That’s gonna be a really good one. Thank you for listening and hope to, you know, you learned something.

Matt Foreman [00:18:00]:
Thank you. Thank you.