Multiple Entities, Multiple Benefits

Welcome to the Profitable Painter Podcast. The mission of this podcast is simple: to help you navigate the financial and tax aspects of starting, running, and scaling a professional painting business. From the brushes and ladders to the spreadsheets and balance sheets, we've got you covered. But before we dive in, a quick word of caution: while we strive to provide accurate and up-to-date financial and tax information, nothing you hear on this podcast should be considered as financial advice specifically for you or your business. We're here to share general knowledge and experiences, not to replace the tailored advice you get from a professional financial advisor or tax consultant. We strongly recommend you seeking individualized advice before making any significant financial decision. This is Daniel, the founder of Bookkeeping for Painters. I'm a CPA that works exclusively with painting businesses, helping them know their numbers and what they mean and save big in tax. And today I'm here with Richard Dunton, enrolled agent and advising director of Bookkeeping for Painters.

Hey, Daniel, I appreciate that nice introduction.

Happy to do it. Be here all day.

Yeah, well, I'm glad you kind of set the stage because I think today we're going to talk about something that's a little bit on the deeper end of the pond. This is something that's you know, more advanced tax planning, more advanced, you know, business structuring. But it is something that we're seeing more and more of when we talk to folks, and it really is a good thing for any business owner to really understand. And that has to do with having multiple entities for your painting business. And by entities, we're talking about business entities, you know, just to kind of set some definitions. If we form an LLC with our state to run our business out of, that's a business entity. Uh, and there may be situations where you actually want to have more than one. You might have kind of like almost like Russian nesting dolls where you have companies within companies. Uh, and you know, it can get a little crazy and kind of expensive if we're not careful, but there are a few situations where it makes sense. And I thought we could talk about two situations that we run into a lot where a painting business owner might want to have multiple entities, uh, and then also talk about how you're going to form these entities, uh, how the taxes are going to work, how money's going to get transferred between the two of them. Uh, and I think this will be a, a really enlightening episode for folks who have gotten a little bit bigger in their companies or maybe thinking along the lines of asset protection or wanting to branch out into other business ventures. I think you're going to enjoy this one.

Yeah, this is great, a great topic. It's something we're seeing more and more of. More folks are wanting to establish more complicated structures so that they save more in tax and protect their assets and also have several business ventures going on simultaneously that they could grow and then sell off later. So I think it's a great topic to dive into today. So I'm excited.

Yeah. So let's talk about like the first case study, and that is using a holding company for asset protection. Now, in my mind, when I hear holding company, I'm thinking of a business entity that holds assets. So those assets could be real estate, could be vehicles, could be equipment. Generally, a holding company is not doing operations. There's— it's just formed to be the owner of things that are valuable. That definition is not, you know, set in stone. There's flexibility there. But that's how I think of a holding company versus an operations company. That is a business that is formed to go and do work and make money. That's one that's very active. So those are kind of the two situations there. Now, you might want to split your business into a holding company that owns the assets and an operations company that runs the daily business. The reason for that is, as an operations company, you have a greater chance of being sued. You have greater liability because you're out there working on people's homes. You're driving down the streets. You have employees. Most of the risk is going to be on the operations company. So if your operations company gets sued and you have separated your most valuable assets into a separate entity, you might have a little bit of asset protection there where the person filing the lawsuit is unable to go after the valuable things that are in the holding company. So for example, let's say one of your contractors falls off a ladder, gets injured, and they don't have insurance and they sue you, your company, they might win a lawsuit. Hopefully not, but maybe they do. Theoretically, they would not be able to go after the vehicles and the equipment and maybe even the real estate that the company uses because those things are owned by a separate holding company that's its own separate LLC. Along those lines, we can think of it, um, the arrow pointing the other way. What if somebody sues you personally? Could they go after your business assets? So now we're talking about protecting the business from yourself. Well, that, that is a very big possibility, uh, and this is where a holding company can come into play. Now, this type of holding company is generally known as a charging Order of Protection entity or a COPE, C-O-P-E. The idea here is that if somebody sues you, they win a judgment, they might obtain what's known as a charging order against you. It means that you owe them money. Now, if you do not have good separation between your business and yourself, that person might be able to use that charging order to force you into liquidating some of your business assets. Or force you into distributing cash from your business to yourself, and then they take that cash. So a charging order protection entity would be an LLC that is formed in a state that has strong charging order protections. For example, Wyoming, Nevada, South Dakota, Delaware, even my home state of Illinois, are very friendly towards these types of entities. They have a strong separation between the entity and the individual. So if someone has a charging order against you, they can't force you to liquidate your assets. They can't force you to distribute the money from your company. Now, if you distribute the money in the future, you know, anyway, then they might be able to access that. But it gives you a bit of a shield around your company and around the assets in that company. So that, that's kind of the, the high-level overview of a charging order protection entity. If you're interested in doing something like this, you know, strongly recommend that you talk to, you know, a tax attorney or a tax professional to find out you know, how it should be structured and what states are friendly towards that. If you do not live in a state that is friendly for charging order protection, such as California or Florida, that's okay. Your holding company can be formed in that state and your operations company would have to be formed in the state in which you do business. But you can still have that co-protection. If you set that up right. Natural question is, well, if I take all my vehicles and equipment, I stick them in this Wyoming LLC, how do I run my business? Well, the holding company that has the assets is going to lease those assets to your operations company and you are kind of just, you know, trading money back and forth. There's not really any tax savings here. But that's how your operations company can use those trucks and not actually own them themselves. You'll want to make sure that you dot your i's, cross your t's. The truck should be titled in the name of the holding company. If there's any loans on them, those loans would be, you know, with the holding company. Make sure you have that separation on paper because, you know, in a lawsuit, the lawyers are going to be all about the paperwork. And you can have the best intentions. You can say, well, this is what I wanted to do. But the only thing that really matters is what's in writing. So I know it's not something that we like to think about a lot. Paperwork is a pain in the neck. But making sure that we have all of our documents correct and the proper owners for everything, that's what's going to protect us, you know, if something bad happens.

And one of the things that I see a lot of folks want to do with these holding companies. It provides that protection if one business is sued so that, you know, they can't get into the holding company's assets. But also, maybe you don't just have a painting business, maybe you also have a pressure washing business or some real estate, and those are also in different entities. And so you could have those different operating companies you know, you have an LLC for your real estate, an LLC for your other non-painting business, LLC for your painting business, and then you have the holding company which owns all of those separate businesses. So it's all getting funneled up into that, uh, that holding company so that if any one of those, you know, if someone trips on the stairs at your— on your real estate and they are suing your that LLC, it's not going to affect the holding company or the other businesses because it's separated off. Or, you know, if something happens in your painting business, it's not going to impact your holding company or the other businesses that you own as well. So not only creates that, uh, separation between the holding company and the, and the operating company, but also if you have other operating companies like other businesses going on or real estate, you can also create that that separation of liability there.

Yeah, I like that. You know, we, we sit down with our clients and we diagram this out, and I like to use circles for each LLC. It kind of makes me think of like a little protective bubble. You know, if someone attacks an asset in that bubble, it's confined to that bubble. It can't move on to the other ones. So it's, you know, it's, it's putting your assets in silos. Or segregating them and building those walls between them. So I think that kind of brings us to our second case where you might have now an operating company that is taxed as an S corp for the purposes of tax savings. This is a situation where you would have an interest in multiple operating companies. And a lot of times when you have multiple partners, you want to set that up as a partnership. The reason being is a partnership is the most flexible type of business entity. S corps have certain rules that you have to abide by. C corps are better, but you have that dreaded double taxation. Partnerships are kind of like the Wild West. As long as all the partners agree, you can handle things however you want. You might have one partner who is a 20% owner, but he's entitled to 80% of the profits. Or you might have one partner who says, I want to take on all the losses. I'll give the profits to somebody else. You can, you can— whatever your imagination can come up with, you can pretty much do in a partnership. Just please put it in writing and have it in your operating agreement because those type of things can kind of get, you know, disagreements can arise from that. So make sure it's in writing. But whatever you guys agree to, you can do. The downside is that partnership taxation comes with self-employment tax, and that's that 15.3% tax on all of your business earnings. You know, it's great for Social Security and Medicare, but it's not good for you. You get very low return on investment. So typically what we'll do is we'll set up an S corp operating company to be the parent of all these child partnerships. It's going to have its stake in the partnership. So for example, if Daniel and I were going into business together, we might be 50/50 partners. And in our partnership, I don't want to be the 50% partner. I want my S corp operating company to be the 50% partner because now whatever income Daniel and I make, my share doesn't flow to me directly because then it would be subject to self-employment tax. It flows to my S corp operating company. That washes away the self-employment tax because now it takes on the tax characteristics of the parent. Yes, I still need to pay myself a salary as the CEO of my operating company, but anything above and beyond that I can receive on a Schedule K-1 and it will be free from self-employment tax. And I can have a partnership with Daniel. I can have a partnership with somebody else. I can have a 10% stake in a restaurant that my friend's opening. Whatever you want to do. There's great scalability here, but it's all going to flow into your one single S corp operating company. And I encourage you to have one S corp operating company. If you have multiple S corps, what happens then? Well, now you're required to pay yourself a salary for each S corp that you have, and that's going to start to erode away those tax savings. Much better to be the CEO of, you know, U Industries and have all these different little subsidiary companies than to be the CEO of 4 or 5 different businesses.

So it sounds like we want to have one company that's taxed as an S corp and then it owns all the other partnerships that you have going on. So you have— maybe you have a painting business, we have a partnership. Then you have a pressure washing business, you have a partnership. Uh, whatever else you have going on, you have those partnerships taxed as partnerships, but then the owner is the S corp that you've established that owns all those. And so you're— it's a— it's effective with, um, keeping your tax bill low because you have that S corp status in, in the main operating company. And instead of having like— because sometimes we have folks come to us and they have like 4 different S-corps set up in, you know, 4 different businesses. And so it's just a lot of additional admin costs and payroll that you're running that's not necessary, where you can just make one S-corp and then have that S-corp own all the, the other businesses and kind of streamline things, make things lower cost admin-wise and also lower in taxes as well.

Yeah, absolutely. Every, every S corp would require its own 1120-S tax return. That's an expensive tax return. If you have child companies, all their income flows to the parent. You file one consolidated tax return and all that income takes on the tax characteristic of the parent. So normally these things would be subject to self-employment tax, but if it's owned by an S corp, now it enjoys S corp taxation. So yeah, that's— I think you did a great job of explaining that. You know, recently we talked to a client who has a painting business and he has some very ambitious goals. He wants to open up 50 different businesses in 50 different locations, and he wants each location to be its own individual LLC and possibly offer equity to the local employees there. And this would be an ideal setup for him. In fact, we, we drew it all out. Was it was really fun. He can have his one primary operations company and it can be, you know, a part owner of all these different little satellites. And all these satellites enjoy their own asset protection and all the income flows up to the top and it goes on one tax return. So we're getting it set up right from the get-go, which is a lot easier if you set it up right from the get-go than trying to undo these things. Now, if you, if you are already set up and maybe you realize like, oh, this isn't exactly the most advantageous way of doing things, you know, we can unwind stuff. You know, we partner with law firms that have really great lawyers who can help us kind of, you know, undo the rat's nest. But it's super important that we have the formation right and the documents right. So, you know, for example, let's say I want to do a holding company and an operations company. So I, you know, I form my LLC in Nevada I've got my operations company in Illinois because wherever you're doing business at, you need to be domesticated there. So your operations company has to be either formed with the state that you're working in or domesticated, which is like a fancy term for saying registered in the state where you're working. The holding company can be elsewhere, but let's say I do that and I put myself as the member of these LLCs. Well, in that case, I don't actually have a holding company and an operations company. I've got two LLCs which I'm the owner of. So we need to have the child companies be owned by the parent company and the paperwork needs to be right because if this ever gets challenged or we ever get sued, we need to show that we did everything correctly to protect that corporate veil, because that's what this is all about, right? We're trying to protect the assets, strengthen that corporate veil, and that's only going to happen if we do things correctly. And the paperwork does matter. So if you're looking at this type of strategy, I strongly encourage you to work with a professional and make sure that you have everything the way it needs to be.

Yeah. And going back to the example one of the clients we're working for, uh, working with, that they want to have all those different, uh, branches, all those different companies throughout the, the U.S., and have like its own LLC formed, and he owns part of it, and then the, the local team is also owns the other part. I think that's a great way if you, if you have those ambitious goals And it reminds me of Les Schwab, who was the, the, uh, the guy who scaled the tire centers across the US back in the day. And Charlie Munger often uses him as a great example of aligning incentives, because Les Schwab did the same thing. He basically— the way he scaled his business was he opened up and opened up all these tire centers everywhere was that he would go in, in a partnership with the local person who was opening the— and operating the store, and he would own a portion of it, and then the local person would own the other portion. And he was able to, to scale his, his business that way. And, and I don't know exactly what sort of holding companies or operating companies he had set up, but I would imagine it was probably something very similar to what we're helping folks, uh, set up, which is basically having that holding company that owns, you know, a percentage of, of all those partnerships. And so you're keeping things efficient tax-wise and also protecting yourself. So I love the, uh, you know, if you have big goals to, to expand to different areas, having aligning incentives with your local team and while keeping a you know, a good percentage going back to you as the, the founder and the owner. I think that makes a lot of sense.

Yeah, for sure. And there's a certain amount of, you know, privacy that can be enjoyed with the correct setup to, you know, keeping your personal name off of a lot of these things can, can give you that privacy so that people, they might know, you know, that this asset belongs to this corporation. This LLC, but it makes it more difficult for them to get to you personally. It's kind of like camouflage, you know, for your money, you know. And we didn't really plan on talking about this today, but, you know, there's another level to this too where you might end up with a revocable living trust that holds some of your real estate or some of your other assets because we don't want real estate owned by an S corp. That's kind of a tax no-no. That's a good way to end up paying more taxes than you really need to. But yeah, like I was saying, one of the things that we like to do is we diagram it all out and we separate your financial life into your operations side and your assets side. And we show how these things are going to flow to which entities before they eventually hit your 1040 tax return, how your real estate is going to rent, from your operations company, how your real estate is going to be held by your revocable living trust, and making sure that we have the most tax-efficient flow. Also, what's going to give us the most asset protection and also what's going to give us privacy as a person. So definitely worth taking some time to do that, especially if you've got some ambitious goals, because the more assets we have out there, the more things we have in play. The more we need to protect them and plan for just in case, you know, someone should try and file a lawsuit against us or something like that. So this is fun. It's kind of hard for, for like a podcast because you can't really see. I would love to throw up the diagram, but if you'd like to see what a sample diagram might look like, let us know on our Facebook group. Grow Your Painting Business. I'd be happy to drop some pictures in there, and you can kind of maybe get a visual of what the flow would look like.

Awesome.

Cool.

Well, love to hear your thoughts. Go to Grow Your Painting Business in the Facebook group and drop a comment for ideas for future episodes. And with that, we will see you next week.