May 1987
Vol 10 No 7
There seems to be a lot of confusion surrounding the use of corporations under the new tax act. Aside from tax considerations, incorporating a business – or becoming a CONTRACTOR rather than an EMPLOYEE in your present occupation and being paid as a corporation – can have a major impact upon your net profits, estate planning, retirement, liability and exposure to creditors. While it's easy to explain some of the benefits of a corporate life, the subject can be quite complex. Consequently, the more you understand, the better you'll become at extracting both short term tactical and long term strategic benefits from it.
To keep the subject at its simplest level, for the small business person, the closely held, one person, owner operated corporation with the bulk of its activities devoted to services OTHER THAN health, law, accounting, actuarial science, architecture, consulting, performing arts or engineering – and which earns less than $5 Million a year – works well. Keeping inside these parameters avoids many of the problems posed by the various regulatory agencies, Internal Revenue Service Code, ERISA, OSHA, HEW, HUD, etc. And it simplifies much of the busy work associated with documentation and record keeping for a corporation.
There are some immediate benefits that accrue to the sole owner of a small service corporation. (a) Pension plan contributions can be larger under some circumstances. (b) A corporation can set up tuition reimbursement plans, Major Medical plans, Prepaid legal services programs, employee benefits programs, travel and trip reimbursement policies, the use of the corporate car (with appropriate accounting for personal use), even meals and use of corporate housing where justified by the demands of the job. (c) Business expenses are 100% deductible to the corporation except for an 80% cap on meals and entertainment expenses. Because business is being conducted by an artificial legal BUSINESS entity, the presumption is that all activity is for business reasons, hence, many deductions are allowed to the corporation which wouldn't be allowed to the individual. (d) When a corporation owns stock in another corporation as an investment, 80% of the dividends received are exempted from taxation.
When a corporation is formed, it's a 'C' corporation. An election can be made to be taxed as an 'S' corporation. There's quite a difference between the two, so this should be considered carefully as to the ultimate use of the corporation. Here's a short run-down on some of the critical differences with regard to your decision.
A 'C' corporation such as is described in paragraph 2 above can choose a tax year which is different from the calendar year – say, January 31st vs. December 31st. Hence a full tax year can elapse between the owner's and the corporation's taxable events. It is the only entity in which all real estate operating losses can be used to shelter ACTIVE income from other sources. Its federal income tax rate is lower than either the individual or 'S' corporation rate between $16,800 and about $300,000 depending upon whether earnings are retained, paid out in salary or dividends. Any dividends it pays are taxed once at the corporate level and again at the shareholder level, but any salary it pays out is a deduction to the corporation and taxed only at the employee level together with FICA and other taxes.
An 'S' corporation distributes any earnings at the end of the year. It has to use a calendar year unless it gets special permission from the IRS to use a fiscal year. It can't shelter ACTIVE income with real estate losses, has restrictions on shareholders and Leo CS of stock, pays tax at the owner' tax rate effectively.
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THERE'S MORE THAN ONE WAY TO SKIN A CAT . . .
The latest version of my Rental Contract no longer uses the Discount Rent. Now I use a REBATE. I've been watching car dealers do that for years and it seems to work O.K. On the other hand, I've been leery of judges who might dismiss my 'discount' and refuse to allow me to claim the full un-discounted portion of the rent due. It seemed a potential weakness to have an ambiguous amount of rent in the contract representing the nominal rent and the discounted rent as well. So I came up with my RENTAL REBATE VOUCHER.
The voucher is printed on the same kind of paper that bank checks are made of. It has a line for Value $___________ and one for Monthly Date:_________ at the top. There's a place on the bottom for the Tenant's Signature and for the Validating Signature of the Owner. Both must be completed in order for the voucher to be used for payment of rent. In the middle of the voucher there's a paragraph which has been typeset along with the above entries. The voucher also has a nice border to make it look as official as possible. It reads as follows:
'This rebate voucher can be surrendered on the last day of the month shown above as a part of your rent payment. It may not be transferred. It must be validated by signature of the owner below, and endorsed by the Tenant if it is to be credited toward your rent due. It is not refundable nor can it be surrendered for cash or any other property other than rental credit. It may only be used on or before the end of the month shown above. It has no other redemption value after 5 P.M. the last day of that month. No rental credit will be given unless a properly completed Rental Rebate Voucher is submitted together with sufficient cash or money order to pay the full rental amount.'
This system works much better than our old discount program for several reasons.
(1) Tenants like TANGIBLE things. The Voucher looks, feels, acts like a check. We send it out the last 10 days of the month ONLY IF WE'VE RECEIVED NO LATE RENT or REPAIR calls/bills in the preceding 30 days.
(2) It re-motivates the tenants to pay on time and to perform their own repairs without involving me. It's explained to the tenant that the entire sum (usually $50 to $100) is forfeited if ANY repair support is required of me. Thus, any expense in excess of the amount of the amount of the rebate should be referred to me, while they should pay for expenses which are less than their rebate. This makes my management system almost totally one that the tenants operate for me.
(3) While there's some bother in getting the Rebate Vouchers mailed each month, it's a lot less trouble than chasing late rents. And where, under the discount system, I might receive the rent a couple of days late without the discount being paid along with the rent, now there's only one rent, the top amount. For instance, suppose I have a Rental Contract which calls for $600 a month, but with a $100 rebate which will be sent to the tenant for each 30 day period in which there are NO REPAIR CALLS/BILLS or RENTS RECEIVED AFTER 5 P.M. the last day of the month. When there's a transgression, the tenant owes the stated $600. If he fails to pay it, then he receives no $100 rebate the following month, and I'll commence eviction proceedings for any lesser amount.
(4) Tenants are human too (despite what you may have heard). They honestly FORGET to pay the rent! I try to arrange it so they receive the Rebate Voucher the week just ahead of the payday out of which rents must be paid. The theory is that they won't use the rents to pay other bills once they've been reminded that it's coming due. It seems to be effective in reducing late or missing rents caused by forgetfulness or budgeting.
(5) And it's a defense of sorts against RENT CONTROLS. I made a 5 year detailed study of rent controls during their last spurt. Nowhere did I see any allusion to discounts or rental rebates. Because rent controls are often applied in connection with a rent roll back to a prior period, my keeping rents at about S75 above the market, then giving a rebate of $50 means that any rent roll hack wouldn't affect me much if I just quit using rebate vouchers and held my rents at the prior levels.
YOU NEVER MISS THE WATER 'TIL THE WELL RUNS DRY . . .
This winter has seen some of the wildest weather in recent years. For the first time I paid to have lawns mowed for 12 months in a row. When it was 30 in Florida, it was 70 in Massachusetts – and vice versa. We went from scorched earth to monsoon in the South during the past year. Air conditioning bills in January. What has all this got to do with single family homes? It created unusual maintenance problems and the need for reliable repair support just at a time when everybody had a problem at the same time.
Is this consistent with the voucher system explained on the prior page? Sure. Just because I can pass on some of my costs to the tenants, that doesn't mean that someone isn't going to have to do the work. When the tenant has neither tools or experience, he'll just resign himself to losing his rebate and pass the buck on to me or to someone I've hired That means I've got to be able to respond or lose good tenants. And I've got to be able to move swiftly to take care of any hazardous conditions on the property to avoid liability too
In the beginning, my wife and I did everything ourselves. EVERYTHING! We'd use the weekends. I worked during the week. I'd run my ads for Saturday and Sunday as an Open House. Then we'd try to get the new prospect to finish the painting and cleaning in lieu of a deposit. Later, we started realizing enough cash-flow to employ others to do repairs for us, but it was a good system while we were short of cash and long on time. Next, we went through a procession of repairmen until we found just the right person. He LIKED to do EVERYTHING from the foundation to the roof – and all the plumbing in between. But there was a major problem. We became dependent upon him! One day he QUIT and left the state.
After almost 10 years, that put me back into the maintenance business with a vengeance. I started from scratch to remedy the situation. Luckily, I had a wife who was learning to operate a computer. We researched all the local daily and weekly papers and entered the names and avowed specialties of everyone who ran an ad over a one month period. Then we sorted them into two files, one by their skills and one by their names/phone number. We ran a listing of those from which to work, and started shopping their prices on each job. After a reasonable amount of trial and error – and some minor disappointments – we assembled list of reliable people who can do a variety of things. We printed labels out on these and put them into a Rolodex file which we can refer to easily. Along the way we learned a lot.
First, the aid and assistance of other landlords was invaluable. I can't stress the importance of creating networks in your own area among other small investors and manager Besides being a source of psychological aid and comfort during periods of depression, they form political groups to help persuade judges to be more responsible. I just read a letter addressed to a local Judge by members of such a group in Dayton, Ohio. Elected officials aren't unaware of the power of landlords scorned. Your network can help shape landlord and tenant law through local lobbies. And when it comes to maintenance problems, networks can be invaluable. Learn to cooperate every chance you get. In my area some of the best repair people I've found – wholesale carpet installers, roofers, eviction specialists, plumbers, cement masons have been referred to me by my peers.
There's an honor code among landlords which you must be scrupulous to observe. DON'T PASS ON A NAME UNLESS YOU'VE BEEN GIVEN PERMISSION. THE OTHER GUY GETS FIRST PRIORITY One time I needed a quick paint job. Terrific tenants needed to move in the next day, but the entire house needed to be painted inside – TWO COATS! A landlord friend loaned me his secret weapon – an entire family of painters who did the job in 5 hours at bargain rates. (There's just no substitute for child labor – at least my folks felt that way.) But before he'd let me use them, I had to promise I'd NEVER tell anyone else about them or use them again without his permission. That's the biggest pain of a landlord, that someone else will lure his carefully built maintenance staff away at higher prices. Don't do it. There's a better way to fit into this situation. Why not sell maintenance services to owners and landlords in much the same way temporary help agencies sell stenographic services?
ENTREPRENEURS HOLD THE FUTURE IN THE PALMS OF THEIR HANDS . . .
Some of my readers have been in business for themselves all their lives. Others have worked for someone else over the same period. Still others have alternated between the two options, or done both at the same time, or had some members of the family with jobs to provide steady income while others were entrepreneurial, building an alternate opportunity. I've been in all these positions. In my view, NOTHING COMPARES TO RUNNING YOUR OWN BUSINESS.
The trick is to get into business with the least risk, investment, effort, cash, and outsiders. So, a service business seems to be best. And because few of today's Yuppie Generation have ever been trained to repair anything, the future seems to be limitless for the person who can fill this gap. I've been accused of moving away from single family house rentals lately, but I think a major opportunity exists for the person who can use skills and contacts gained from house investments to enter the world of business. Both the realities of the market and the new tax law make this a logical choice. Here's one way to do it.
Commencing with the maintenance resource list discussed on the prior page, it's a short step to opening a 'one stop' repair referral service. Whether or not you use a computer or a Rolodex file, run an ad in the For Rent columns or the Handyman colums if your paper has them and leave it in there on a permanent basis. Here's what it might say:
S.O.S. REPAIRS!
789-5555- 24 HOURS!
ONE CALL DOES IT ALL!
The idea is to attract attention, make the message succinct, keep it simple and easy to read. The toughest part is the pricing. You've already determined what the going rate is for lots of jobs that you have in your file. Now you've got to create a 'spread'. Here again, much of the work will have been done for you. The average homeowner is totally ignorant about repair costs while being motivated to get the required work done quickly, neatly, reasonably, finally. The average handyman type is a refugee from a boss. He's already given up job security for breathing room, but he needs to know where his next pay check is coming from. By inserting yourself into this situation, you can on the one hand charge the owner for finding the person he or she needs and on the other hand, generate lots of work for the repair specialist. Each should be willing to pay between 5% and 10% for this service. That means you get 10% to 20% on every job with a total additional investment of a special phone line, answering machine, newspaper ad contract, and maintenance contracts. Remember, the other guy has the license.
All you do is to take the call, find out what's needed, make a rough estimate and communicate that to the caller. In each area, procedures will be different, but you'll need a service contract with both owner and serviceman, credit card number and merchant account. You collect from the owner and disburse to the workman. This way YOU always get paid or have legal redress the same as any other businessman. This may seem too much trouble for you, but it may not be for your 20 year old offspring – male or female – whose only other option is to work in a dead -end job for minimum wages. Or for your retired parents who need more income. Or for your spouse who's desperate to be able to quit his/her job and to be the boss.
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Quotation not permitted. Material may not be reproduced in whole or in part in any form whatsoever.
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