Every real estate investor or business owner knows that taxes take up a big chunk of profit and earnings from investment income and capital gains. Understanding how the tax system and tax brackets work may help you reduce your tax burden and liabilities. As a real estate investor, you may be able to minimize income taxes either by hiring family members or your C corporation. This article focuses on the possible tax benefits of outsourcing business contracts to a C corporation owned by you. Interested in learning more? Check out our article, Using Your Family’s Tax Brackets To Reduce Your Tax Burden. How the progressive tax brackets work Progressive tax brackets start taxing the lowest amount of income at the lowest rate. The tax rate increases as income rises. Simply put, this means that you would fall in a higher tax rate bracket if you are a high earner; likewise, low-income earners pay at a lower rate. Here’s a (hypothetical) example of how progressive tax brackets can work: Less than $15,000: 7.5% Between $15,000 and $40,000: 15% Between $40,000 and $150,000: 20% Over $150,000: 30% An annual income of $100,000 puts you in the 20% tax bracket. Note: The tax rates would be applied progressively—the first $15,000 will be taxed at 7.5%, the next $40,000 will be taxed at 15%, and the remaining $45,000 at 20%. Using Your C Corp’s Tax Brackets Similar to individual income taxes, C corporations have tax brackets. This is how it generally works: The first step is to set up two businesses. One would be set up either as a sole proprietorship, a partnership or an S corporation. This business would be your main real estate business, operating as a pass-through entity. The income you get from this business is taxed at your individual tax bracket. The second business you set up will be taxed as a C corporation. The next step is to hire your C corporation for tasks that can be justifiable and with payments that are reasonably within market rates. This can include things like property management, cleaning and maintenance or even digital marketing services. When you pay your C corporation for fulfilled and completed contracts, this counts as eligible expenses that can be deducted from your pass-through entity income. The goal is to transfer this income from your higher income tax bracket to a lower business tax rate. So if your individual tax bracket is at 40%, you can potentially transfer income from your pass-through entity real estate business to your C corporation, which can be taxed at a lower rate of say, 25% (for example). Things to consider when using a C corporation to minimize taxes When you hire your C corporation, it is important to keep records such as contracts, agreements and invoices. The paper trail will help you in the event of an audit. You need to ensure that the services or products provided by your C corporation are essential for your business and are related to typical business operations. When your business outsources a contract to your C corporation, the payments have to be justifiable with going industry rates. If you are not sure about what is considered reasonable, you can do a quick research on the internet or put out a request for proposal in order to gauge bid prices. While your business deducts the payments to your Corporation as an eligible expense, the Corporation would record this income when filing a tax return. Ordinarily, all of these money movements can be complicated, therefore it is important to keep constant records of all expenses, payments and transfer of income. All contracts and agreements should be documented appropriately. You may need an accountant to ensure this is done properly. How to manage income from your C corporation You are probably wondering how effective it would be to use a C corporation to manage and reduce your taxes and how to go about receiving your income from this business. Well, this is a valid concern and there are various ways to go about it, some more tax efficient than others. Through dividends: While you can pay yourself a dividend as an owner of the C corporation, this may not be the most tax efficient option especially as you set up the company to minimize taxes in the first place. This is so because dividends are an after-tax payment, meaning, they do not reduce the C corporation’s taxes. Also, these dividends would be taxed in your hands when received resulting in double taxation. Employee payments: If you work in the capacity of an employee and are actively involved in the day-to-day operations of your C corporation, you can receive employee salary payments. However, you want to make sure that payments received are based on market standards but also minimal enough to qualify for eligible tax benefits. You would need to fill out Form W-2 form for tax returns as an employee of the C corporation. Other options include receiving tax exempt employee benefits or loaning out money from the C corporation to your sole proprietorship, partnership or S Corporation. In conclusion If you’re looking for ways to reduce taxes on your real estate business, you can explore the C corporation option. While this may require effort to execute, it could lead to potential savings for your business.