Wednesday, April 18, 2012

Do Regional Centers violate federal income tax laws?

I recently came across this scenario, so I felt I should share it with you. As you know, many Regional Centers happen to work as LLC's (Limited Liability Company), and LLC's can elect to be taxed as either a partnership, sole proprietorship, s corporation or c corporation, depending on the number and type of members.

For an LLC to be taxed as a sole proprietorship to avoid double taxation, the IRS requirement is posted at,00.html.

For an LLC to elect taxation as a partnership or S corporation to avoid double taxation at both personal and corporate levels, the number of investors is limited by law and they must be eligible to have US Social Security Numbers (i.e. Citizens and residents) and LLC's that have members who aren't citizens or permanent residents may be committing tax fraud when they admit members who aren't citizens or permanent residents and continue single taxation when legally they're required to have double taxation. As such, it is EXTREMELY IMPORTANT for investors to see if the LLC's are complying with the tax laws as the failure to comply with tax laws is imputed to all members of an LLC. An LLC which engages in single taxation when legally they're supposed to have double taxation (electing to be taxed as C corporation) may possibly be engaging in tax fraud.

It is a lot more advisable for investors to take their money and invest in their own business where their own CPA & adviser can guide them on how to proceed and what changes to make at what step, because it is better than forfeiting funds to the IRS due to the carelessness of an irresponsible idiot.

As such, please feel free to ask the Regional center you are considering about their structure and how they are complying with the tax laws.

The above is simply my personal opinion and is NOT to be construed as legal advice. Please consult your own CPA and attorney to independently check facts for yourself and get accurate advice. Also, please double check with the IRS if a non-resident and non-citizen can legally qualify for single taxation in an LLC that elects to be taxed as a partnership or S corporation, before you invest your hard earned money in a Regional Center that will cause you to lose your hard earned money.

Taxation of LLC Income and Loss

Speaking strictly in taxation terms, an LLC, when taxed as a partnership or sole proprietorship is not a separate tax-paying entity in the eyes of the IRS. Each member is separately and individually liable for the taxes on his share of the LLC (profits, losses, deductions, and credits). Each member must report his share of his tax liability, and each tax liability retains the same character it had when earned or incurred by the LLC. The pass through of items to members means that income avoids being double taxed, and losses may offset income that the member may have from other sources.

In direct contrast, a C corporation is a separate entity for even tax purposes and is such, is required to pay its own taxes. Income and profits are taxed at the corporate level when earned, then taxed again when distributed to the various shareholders as dividends. Dividends are always taxable as income, irrespective of the source. Therefore, when distributing corporate profit, it may be advantageous to pay the gain as salary or bonus rather than as a dividend, which is tax-deductible to the corporation.

S corporations are taxed in a somewhat similar fashion as are partnerships. The tax burden on retained earning in an S corporation passes through to the individual shareholders. Each shareholder reports his percentage share of the income on his tax return. However, the income can be re-characterized. For example, if the S corporation earns profits that would be taxed as ordinary income if earned by an individual, the S corporation can pay the earnings as a “distribution to shareholders.” When one received payment in this fashion, they can avoid Social Security and Medicare tax, currently a 15.3% tax savings. One must tread carefully with the LLC as an S corporation because the LLC may be taxed as a C corporation, even if the S corporation election is made, if the requirements are not met and it is operated like a “regular” corporation. For example, if the entity has even one foreign owner it will be deemed to be a C corporation for taxation purposes. This means, everyone will be subject to double taxation. Similarly, if excessive passive-type income (such as rental income) is generated by corporate assets or if the corporation disposes of assets that had built in gain when the election was made to be treated as an S corporation, the IRS may see fit to tax the LLC as a C corporation.

LLC Termination

Change in ownership of the corporate shares does not terminate a "C" or "S" Corporation for Federal Tax purposes, unless the change involves foreign owners. Because a multi-member LLC can be considered a Partnership, it is subject to the Termination Rule of IRC Section 708(b). An LLC terminates for Federal Income Tax law purposes whenever 50% or more of the interest in capital and profits are sold within a 12 month period. This means that even though the LLC may technically still be in existence under State Law, for tax purposes, it terminates and re-starts. This has the same effect establishing a new entity for accounting purposes, and brings the current LLC tax year to a close. 

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