Different partnership question

[oceanlovin'ea]

New client came in last week. He is in Florida and he is going into partnership with someone in Georgia. They will set up the partnership in Florida since Florida does not have a state tax. They are consultants in the field of CAD, software development, training, etc.

My first suggestion was that they set up an LLC, but consultants can't be limited partners. They would be general partners. This would mean that they don't have limited liability and all of the guaranteed payments and profit from the business will be subject to self employment tax. So my question is "What is the advantage to being an LLC?" Is there any?

What would be the best entity choice for them? It would seem to me that the only way to limit SE tax is to be an S corp.

Here are 2 more wrenches thrown in. - First the partnership agreement is for 1 year. If at the end of the year, they are working together well and neither has had other offers that are more profitable they might continue the partnership. Second, since the kind of work they will be doing is something they can do over the internet, they will be working with companies in different states and even a possibility they will work with a firm in Trinidad.

HELP!!!!! This is definitely a challenge to come up with the best tax solution for them but a most interesting one. I have been reading a lot and most things I have read do not tell you what to do with the companies that can't be limited partnerships.

Thanks

Linda

[erchess]

My Policy

I don't advise anyone on choice of entity. I insist that they go to a lawyer to get help selecting an entity and of course to have the entity created. I have a tax lawyer with whom I have a handshake agreement that has so far been honored to the letter. When I call in with a client he charges his normal fee to help them choose their entity and set it up but refers them to me for their tax prep work. The really neat part is that if I get stuck on a return he will help me out in exchange for his hourly fee but never more than half of the fee I collect from the client.

I have the highest respect for your knowledge and intelligence, Linda, but unless you are a Tax Attorney I don't think you should be advising people on choice of entity and in any event I don't think you want to try to work with an entity that was not created by some sort of lawyer.

[oceanlovin'ea]

They have already written up their partnership agreement. I was just trying to figure out the best tax situation for them. I did suggest they consult a lawyer to write up the agreement since it is much more complicated than setting up an s corp.
He said it took them about 3 weeks to iron out all the details and that if they decide to continue the partnership after the year is up, they will consult a lawyer to write a permanent agreement.
So I was just looking at this from tax standpoint and wondering if I was correct in my thinking from what I read that they would be general partners since they are in the business of consulting. This would mean that all income from the business, both guaranteed payments and bottom line income would be subject to SE tax. I was wondering if this was the best tax strategy for them. It doesn't see to me that setting up an LLC would be of any benefit to them.
I also mentioned that they would be working for people in other states and in Trinidad to see if they would be required to do state returns for those other states.

I am careful about giving legal advice. When we talked about setting up an LLC, I gave him the forms and told him he would have to file for that himself or fill out the forms and I could copy the information off them and do it for him online. But he is quite capable of doing it himself.

Thanks for your imput.

[Bees Knees]

It is my understanding that when state law says a certain professional cannot be a limited partner, it is referring to that partner’s own malpractice. I’m not a lawyer so I’m not sure what is meant by “consultants can’t be limited partners.”

I am guessing that maybe that only refers to the consultant’s own malpractice, not necessarily the other debts and obligations of the business.

If that is true, I would still set them up as an LLC and only subject SE tax to their guaranteed payments. Maybe you should explore more fully what is meant by that statement, “consultants can’t be limited partners.”

[oceanlovin'ea]

Beanna

I got that information from the seminar I attended last year that Beanna Whitlock gave on LLC's. There is a list of 7 professional services that can't be limited partners: health, law, engineering, architecture, accounting, actuarial science and consulting. It says all the income from those professional LLCs is subject to SE taxes.

I am going to call her this morning.

Linda

[Gretel]

It is my understanding that when state law says a certain professional cannot be a limited partner, it is referring to that partner’s own malpractice. I’m not a lawyer so I’m not sure what is meant by “consultants can’t be limited partners.”

I am guessing that maybe that only refers to the consultant’s own malpractice, not necessarily the other debts and obligations of the business.

If that is true, I would still set them up as an LLC and only subject SE tax to their guaranteed payments. Maybe you should explore more fully what is meant by that statement, “consultants can’t be limited partners.”

I agree with Bees. When I started my own LLC I did a lot of reading in the state laws. My understanding is also that a Professional Limited Liability Company cannot get out of malpractice issues but if f.e. a clients falls and sues you the PLLC will protect.

[Bees Knees]

I got that information from the seminar I attended last year that Beanna Whitlock gave on LLC's. There is a list of 7 professional services that can't be limited partners: health, law, engineering, architecture, accounting, actuarial science and consulting. It says all the income from those professional LLCs is subject to SE taxes.

I know of no federal law that contains such a list. I know that the IRS tried to issue proposed regulations to that affect in 1998 but Congress struck down those regulations [Proposed Reg. §1.1402(a)-2(h)]. Nothing new has been issued by IRS since.

If those are the proposed regulations your seminar speaker is referring to, she is wrong.

[Bees Knees]

I just looked up those proposed regs.

Proposed Reg. §1.1402(a)-2 was issued by IRS in an attempt to define a limited partner with respects to the computation of net earnings from self-employment. Proposed Reg. §1.1402(a)-2(h)(5) says:

Exception for service partners in service partnerships. An individual who is a service partner in a service partnership may not be a limited partner under paragraphs (h)(2), (h)(3), or (h)(4) of this section.

Proposed Reg. §1.1402(a)-2(h)(6)(iii) says:

A service partnership is a partnership substantially all the activities of which involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, or consulting.

However, at the beginning of Proposed §1.1402(a)-2, the following caution appears:

Caution: The Treasury has not yet amended Reg. §1.1402(a)-2 to reflect changes made by P.L. 105-34.

Public Law 105-34, Section 935 says the following:

No temporary or final regulation with respect to the definition
of a limited partner under section 1402(a)(13) of the Internal Revenue
Code of 1986 may be issued or made effective before July
1, 1998.

Proposed Reg. §1.1402(a)-2 was issued prior to July 1, 1998. Therefore, it cannot be used as any kind of authority. Congress specifically wrote Section 935 of P.L. 105-34 as a result of the IRS issuing Proposed. Reg. 1.1402(a)-2 some six months earlier.

Thus, you cannot rely on those regulations for anything, and I am surprised a seminar speaker is giving any consideration to them as having any kind of substantial authority.

[oceanlovin'ea]

Just talked to Beanna Whitlock

They can set up an LLC and will be limited partners in the LLC. Because consulting is a service business and all the income will be from services they perform, all the guaranteed payments and draws will be subject to SE tax.

My thinking was mostly right but she clarified a few things for me.

I appreciate all your imput. You are a smart bunch.

Linda

[ChEAr$]

don't forget

to advise the Georgia fellow that just because the LLC or partnership is headquartered
south of his border, he will still report income (or loss) on his Georgia tax return.

[oceanlovin'ea]

most definitely

They will probably be consulting for companies in several different states due to the fact that what they do can be done online or by conferencing so they may have to do many state returns.

Beanna advised me to keep them close to my hip and to make sure they keep their records on a project by project basis. That is good advice and I will do that.

Linda