Can you hire your own company to do work on a duplex you own ?

[unliable]

What is the name of your state? Colorado

I have a duplex and also own a construction company. Albeit its just me working in the company mostly but it is incorporated. So the question again is: Can I hire myself to work on my duplex and write off materials AND LABOR costs? Then hold the money in the S Corp and withdraw it as a non-dividend distribution (while also taking a fair market wage and paying taxes on the wage only).

I haven't a clue as to what tax law states but I have the feeling I am some how laundering money, anyone know the applicable laws offhand?

 

[Taxing Matters]

Your facts are not entirely clear. But I gather that the construction company is organized as a S-corporation. How about the duplex — how is owned? And do you rent out both parts of the duplex, rent out one side and live in the other, or what?

Note that you won't end up saving tax with what you propose. Let's say your hire out your S-corporation to do work on the duplex at the same rate you'd charge other customers (this is important for several reasons — if you do it substantially below market rates there can be both tax and non tax problems). Your S-corporation then buys the materials and pays you to do the work.

Let's say you get paid $1,000 for it. You are an employee of the S-corporation so that $1,000 are wages subject to employment taxes. The S-corporation may deduct what it actually paid you — the $1,000. That will reduce the taxable income you have flowing up to that year from the S-corporation by $1,000 but then that $1,000 ends up included on your personal return as wage income. In short, it's a wash. The S-corporation cannot deduct for labor you provided that it did NOT actually pay you to do. So there isn't a tax savings in here for you.

Now let's look the materials. You have to pay the corporation for the materials it uses for the job — so you cut a check for, let's say $5,000 for supplies. That $5,000 is income to the corporation, but it also gets to deduct what it paid for those supplies. Assuming no mark up on the supplies, its cost is also $5,000. So the materials end up being a wash here for you. You don't get a tax savings from the materials.

In short, the end result for income tax for you here won't end up materially different than if you just buy the materials yourself and do the work to the duplex on your own rather than running it through the corporation instead.

Note that that what you propose is not money laundering. The concept behind money laundering is that money that was received from some illegal enterprise is funneled through a series of transactions that at the end would make it appear the crook got the money by legitimate means. The term money laundering came from the idea that the crook takes "dirty money" and through these transactions washes the money so that at the end it is "clean." In short, it's used to help criminals hide their crimes. If you aren't involved in criminal activity you have no need for money laundering and what you propose to do is not something that would help you do that anyway.

 

[unliable]

Thank you for your in depth response!

Yes you are correct in assuming that I live in one side of the unit and the business is an S Corp. Also the work is only being done in the empty rented unit. However as for wages... I typically bill myself out at 50-60 an hour and pay myself 30-35 an hour which is well with in range for a Construction foreman. So there's usually 40% taken by the business (what business operates at a net loss? paying employees 100% of earnings seems illogical) of which 20% can be withdrawn as a non-dividend distribution. Unless I'm doing my taxes wrong, then well...

 

[Taxing Matters]

Ok. The rental unit is empty. Have you been renting out it, or has it never yet been put into service as a rental? Why is it empty now?

If I assume that the rental qualifies as an active rental and that the work you need done is just repair work rather than improvements to the property, then it works out like this.

Let's suppose you hire the S-corporation to do the repair work for you. The repair work takes 50 hours to do and you bill the labor at $50/hour, so that's a total of $2,500 for the labor. The S-corporation pays you $35/hour for the 50 hours of work, so you get paid $1,750 for that.

That $1,750 of wage income is taxable income to you. In addition to that, you'll have 15.3% of that amount to pay for FICA (Social Security and Medicare) taxes, half paid by you via a payroll deduction and half paid the corporation itself. So the total FICA tax is $267.75, your half of which is $138.88 and the employer's half is $138.87.

The corporation has $2,500 in income for your labor. It gets to deduct from that the $1,750 it paid you for the work, and the half of the FICA tax it paid for you, for a total deduction of $1,883.87. That leaves a profit of $616.13 on the labor for the job. That profit then flows up to you to be reported on Schedule E of your return. It is not just the amount of profit you distribute that is included in your income; the entire profit of the S-corporation is included in your income.

Now, I assume the duplex is simply owned by you personally or through a single member LLC that is disregarded for federal tax purposes. the money you paid for repairs would be a deduction for the rental activity, assuming it is an active rental. (If the work were improvements to the duplex, it would not be a deduction but rather an addition to basis.) So that's a deduction of $2,500.

So what do you have at the end of this. You paid $2,500 to the S-corporation for the labor for the repair, which you deduct. You ended up with income of $1,750 in wages plus $616.13 in profit from the S-corporation, for total income to you on your personal return of $2,366.13 on your return. So the net difference is a reduction in taxable income of $133.87. If you were in the 24% tax bracket that means your total income tax savings from using the S-corporation is $32.13. You'd also save $6.20 in Colorado income tax. But you also ended up paying $267.75 in FICA taxes for your labor. So in the end, you saved a total in income tax of $38.33 but paid out $267.75 in FICA taxes for it. Ultimately it's costing you tax in this example of $229.42 to do it this way

Now let's look at the alternative way you could do the repairs. Again, assuming you own the duplex yourself or through a single member LLC, you could just do the work as the landlord and not go through the LLC. Your labor in that case results in no taxable income to you nor any deduction for you. As a result, there is also no FICA tax for you to pay for your labor. There is simply no tax impact for your labor. So you'd be better off doing it this way because you don't have that FICA hit you take running the work through the S-corporation.

Note that if there were no FICA taxes the result would have been the same either way — no ultimate tax impact. So you'd still not save any tax running it through the S-corporation. But because you do have pay FICA taxes on your wages, it ends up being worse for you to use the S-corporation.

 

[unliable]

Very very helpful information,

I am currently reading up on the pass through business deduction so I don't have to waste your time more. It doesn't seem to be factored in on your calculations though.

 

[Taxing Matters]

Very very helpful information,

I am currently reading up on the pass through business deduction so I don't have to waste your time more. It doesn't seem to be factored in on your calculations though.

No, my example was meant to be fairly simple to illustrate the concept. That concept still holds true even including that deduction. That deduction simply lowers the effective rate of tax on the business income. It does nothing to help with the FICA tax problem, however.

 

[unliable]

The biggest part of this scenario I misunderstood was that the amount distributed is still taxed. I thought that portion was considered tax free not just FICA tax free.

Thanks for taking the time to help me understand.

 

[Taxing Matters]

The biggest part of this scenario I misunderstood was that the amount distributed is still taxed. I thought that portion was considered tax free not just FICA tax free.

Thanks for taking the time to help me understand.

You're welcome. I'm glad that the discussion was useful to you. Just a minor note though. The income of the S-corporation is taxable to the owners regardless of whether that income is distributed. So even if you make no distributions and keep every penny of profit in the S-corporation, you still include all that profit on your income tax return.