Taxpayers Also Play a Role in Our Tax Code’s Complexity

We can all agree that the tax code is over-the-top complicated and continues to get more complex with every year and every legislative session that passes.

And it’s all our fault. Because the human race is intelligent, it tends to create complexity—just think how more intricate our lives are compared to our ancestors. And with advances in modern technology, it gets crazier all the time.

The IRS and Congress can’t take the full blame for the tax code’s immense opaqueness; taxpayers often create their own higher levels of tax difficulty for no apparent reason.

I see it most often with the creation of needless entities.

It’s popular right now to own a LLC. Buy a rental property, put it in a LLC. Start a business, form it as a LLC. You may not realize this, but for tax purposes, creating a LLC also brings an additional tax liability and plenty of extra paperwork.

While forming this type of small business is the right move in some cases, it can also be a needless waste of time and money. The key is knowing the difference.

Here’s a good example: A week ago a client brought me a postcard from his state advising him he owed filing fees for a LLC I was unaware that he owned. The only asset involved in the LLC was one acre of raw undeveloped land. There was no business activity whatsoever. I asked him why he had formed the LLC. He said he heard it would be a good tax write off. Unfortunately, it isn’t. Not only that, but if he thought it was such a good tax write-off why didn’t he tell me about it when he formed it a couple of years ago?

I told him that in our state, California, a LLC is required to file a tax return and pay a minimum annual franchise tax of $800.  Add to that the required annual statement and filing fee with the secretary of state and my fee for preparing the tax return and it’s clear that he created needless tax confusion complexity. My client began to sour at the monster he created.

It may have been a different story if there was a business activity involved with the raw land--perhaps a lease or a farming activity. Even then, careful consideration should be given to the choice of entity, if any, in which to deposit this asset. There are legal as well as tax issues to contemplate and discuss with professionals.

When he told me he was going to dissolve the entity, I told him to visit his attorney first to discuss the legal aspects.

For legal reasons forming a corporation or a LLC may be the best course of action. But here again I wonder if a good insurance policy won’t provide the necessary protection for one’s personal assets in the event of a lawsuit.  I’m not saying you shouldn’t form a LLC or a corporation. But I do believe this is something that you should discuss thoroughly with your attorney as well as with a qualified tax professional.