What It Takes To LEGALLY Upstream Income (And Why You Need to Know This)


One of the tax planning tools that has been around for years (decades) is the technique of “upstreaming.” I first learned about it right out of college in Reno, NV. At that time there were a lot of California business owners who were fed up with the high state income taxes and wanted to find legal alternatives. They wanted to upstream income to Nevada.

That was a few decades ago (yes, I have been a Tax Strategist that long) and not much has changed. But the bad information has become more and more prolific and I’ve found, over the years, that my information has been ripped off again and again. In fact, I had someone recently send me an email at Diane@DKTaxServices.com to ask how my program was different than another guys. It was EXACTLY like mine was - only 8 years old. That’s because this guy had been a client back then, had a strategy and then duplicated the advice I gave him again and again. Well, he has one strategy and only one, and he’s doing like we did 8 years ago. A lot has changed in that time.

Upstreaming income is a solid technique, provided you do it right. And right now there are a lot of tax advisors out there giving bad advice.

Why upstream? Let’s start there. You can upstream from one company to another that is domiciled and has nexus in another state. If it’s a C Corporation, you won’t pay your home state income tax. Another technique is to divide out the multiple streams of income you have in your company to separate out the active income from the passive income. (This is one that I personally do) You might want to upstream income to legitimize an asset protection plan where you have separated out tangible and/or intangible assets. Or you might want to upstream to another company to take advantage of a separate tax structure (corporate as well as individual). Or you might want to upstream to another company that has been set up to flunk controlled group issues so you can have nondiscriminatory benefits without having to include other employees of the first company.

Upstreaming is a fantastic tax strategy, in the right hands. You need to prove economic substance. In other words: Why upstream? Is there a reason for this strategy other than you want to pay less tax? Right now we are required to provide economic substance, but the definition is more subjective. One of the changes that Pres-Elect Obama wants to make is to create a codified (ie, specifically in the law) definition of what economic substance is. This could be a big issue in the future. We’re already planning for it right now, and assuming it will happen, with the tax strategies that we set up. (That way our clients won’t get caught unaware.)

You also need to have the right corporate documents to provide an audit trail for the strategy. For example, let’s say that you have a doctor with fixed assets in her practice. She wants to move those out to another entity for asset protection reasons. Then she realizes she can provide some nice benefit plans provided an unrelated party owns the 2nd entity. In this case, we needed to use Agreement # 7 Membership Interest Transfer Restriction, Agreement #34 Equipment Lease Agreement and Agreement# 29 Sale of Business Assets.

This will protect the doctor in case something happens with the ownership of the 2nd entity (ie, the owner flakes on her and she wants to get the assets back) and establishes economic substance by providing a clear trail for the sale of business assets and the resulting lease back.

The Agreements and their numbers are part of Megan’s secret cache of agreements - “97 Agreements Your Business Can’t Live Without.”


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