Circular question

[JG EA]

A single member LLC is on a Schedule C and wants to keep the LLC as clean as a Corporation would be as far as bookkeeping and any other items that will end up on the C. So, I am trying to think things through to know how to look at some things. TP is very concerned about not being in a position of using the LLC for anything personal and therefore piercing the protection of the LLC.

Telephone - one line into the house - but business usage can be claimed for LD calls/ voice mail. Since the phone is not in the name of the LLC then it seems the clients should bill the LLC - the LLC pays them and the number goes on the C. What do you think?

Also, Since office in home expenses are use of personal assets, would it make sense to also bill the LLC for "rent" and put that number also on the C.

The thing I'm having trouble thinking though that if it were a corporation it would be a deduction for the corp, but income to the clients. But if that were the case in this situation it would be a wash. But on a normal Sch C it would be a deduction. HELP. I'm going in circles here.

[Gary2]

The core question seems to be protecting the LLC from being pierced. That's a legal question, not a tax question, so you're asking the wrong people.

From the perspective of federal taxes, the LLC simply doesn't exist. The only value in billing for phone usage is to help manage the record keeping. The client will still need to prove that the phone calls were for business purposes; nothing about having the client as an individual bill the LLC will prove it was a business call. With or without the bill, the same number will show up on the Sch. C.

As for renting the office, it simply can't be done. The LLC doesn't exist, so you have the Sch. C paying rent to the taxpayer - which isn't possible.

[JG EA]

Thanks this helps me. It is a legal thing and the attorney keeps telling them to ask me how to do it on their return. He gave them a print out as to dos and don'ts like never using the checkbook to pay any personal expenses. So, I am going under the assumption that if something is part personal and part business the TP should pay for it with a personal account and get reimbursed with the LLC account.

I can see from the viewpoint you gave me that it wouldn't make any difference on the C if the TP took OIH without worrying about being reimbursed for it. I guess that would apply to SMR on the autos also.

It is still confusing but it is getting clearer.

[Koss]

Agree with Gary2

As Gary noted, the question of whether, or how, the limited liability can be "pierced" is a legal issue that is determined entirely by state law, and not by tax law.

Basic accounting issues can come into play. It is certainly true that anyone operating an LLC as a sole prop on Schedule C should have a separate business checking account. Personal expenses like grocery shopping should not be paid out of the business account, and business expenses should not be paid out of the personal account. And this practice will in fact help demonstrate that the business owner is keeping the business operation separate from his personal affairs.

But the question of how easy or difficult it is to pierce the LLC varies from state to state, based on case law, statutory law, and on the individual facts and circumstances. I'm not an attorney. But state and county judges should understand that an LLC, under state law, is a legal entity that is separate and distinct from the members, even if it has only one member, and they should understand that the tax treatment of the entity under federal law does not change the fact that it is a distinct legal entity under state law.

The entity classification under federal tax law, by itself, should not be grounds for the limited liability to be pierced.

If your client's attorney does not grasp this concept, then your client needs a new lawyer.

With that being said, it may be that your client is not asking his attorney the right questions, or that his attorney does not understand the questions your client is asking, or that your client does not understand the answers he is getting from his attorney.

For a taxpayer who is not an attorney or an accountant, it's pretty darn confusing. The single-member LLC is a sole prop for federal tax purposes, but this does not make it a sole prop under state law. It remains an LLC, and that means that it has whatever protections are afforded to it under the applicable state law for LLCs. The idea that it is one type of entity under federal law but a different type of entity under state law is not something that most clients are going to grasp intuitively.

And even within the realm of tax law, it can get a little goofy if you're not careful. For example, one guy I worked with was online at the IRS website, applying for an EIN for an LLC, and when it got to the part where you indicate what type of entity it is, he selected sole proprietorship.

That's not how it works. You need to indicate that the entity is an LLC, and then, in another area of the form, indicate that the tax treatment will be that of a sole proprietorship.

So the IRS first needs to know what type of entity it is under state law, and then, with that information, one can determine what type of entity it is under federal tax law.

This may be part of what is confusing your client.

BMK

[oceanlovin'ea]

I operate my business as a sole proprietor and file a Schedule C for my business. I did not set my business up as an LLC.
When I pay some of my bills, such as my cell phone, I pay 1/2 of it from my personal account and 1/2 from my business account. I do not deduct anything for my phone line coming into the house. I use my cable company, Brighthouse for my phone service. It is a flat rate with everything included. It is just a personal expense for me. I do pay for the internet from my business account.
When I do my tax return, I take a mileage deduction and an office in home deduction. But the business does not reimburse me for those expenses.
As a sole prop, your business is you and you are your business. So reimbursement for mileage and OIH is unnecessary in my opinion.
Being an LLC and taxed as a sole prop would not change any of the expenses above. If I were an LLC, I would still operate the same way.

Linda, EA

[Gretel]

My thoughts.

The bad thing about LLC's is that there is not a lot of court cases yet that would clarify some issues. Even if this is a legal issue, if and how records are kept, have a bearing on how an attorney would try to pierce the veil. If a client is that concerned he probably should consult with a tax lawyer experienced in LLC's (if he can find one). I know attorneys who, because of all this uncertainty recommend only corporations (probably not necessarily in the best interest of the client).

Now, a lawyer (or accountant for that matter), tends to go overboard if not certain about the position.

In absence of a good tax lawyer I would bill the LLC (as you, JG, suggested), I also would bill for OIH expenses. Unless losses, the expenses should jive with the tax return. If OIH limitations come into play, I would add 2 more lines to the P&L: 1. to back out the paid OIH expenses, 2. add the allowable amount, if any.

I know this sounds complicated, but better save then sorry until we have better guidance. Maybe he should be a corporation in the first place. I long for a client who desires a conference between him, attorney and accountant BEFORE doing anything.

[BHoffman]

I'm curious - if the client wants the structure of a Corporation, why does he not make an election to be taxed as one?

[JG EA]

Thanks again all.

...That's not how it works. You need to indicate that the entity is an LLC, and then, in another area of the form, indicate that the tax treatment will be that of a sole proprietorship.

So the IRS first needs to know what type of entity it is under state law, and then, with that information, one can determine what type of entity it is under federal tax law.

This may be part of what is confusing your client.

BMK

My client is not confused - I am. TP decided on Sch C and that is how the atty filed it.

BHoffman: I'm curious - if the client wants the structure of a Corporation, why does he not make an election to be taxed as one?

The reason the TP wants it to be so clean is because of liability and to make a clean accounting system in case they sell the business. The reason The TP wants to be taxed as a Sch C is more a matter of simplicity I think. Part of the reason is that is that is is familiar. Also a reason is they sought advise from other preparers (which I encouraged). Some accountants gave reasons for S-Corps, some for partnerships. But TP feels like the information was not clear as to why. I was reluctant to come to a conclusion on any entity - so did not advise but left it up to them. Also I am not eager to do daring things like not paying SE tax on an LLC or leasing equipment to a corp to save SE tax (things the atty said to ask an accountant about). So that's why I said to shop around. Anyway to make a long story short the client made the decision to remain a Sch. C but to completely change bookkeeping, went to a QB class, and now will keep the LLC checkbook and associated statements absolutely clean.

Gretel: In absence of a good tax lawyer I would bill the LLC (as you, JG, suggested), I also would bill for OIH expenses. Unless losses, the expenses should jive with the tax return. If OIH limitations come into play, I would add 2 more lines to the P&L: 1. to back out the paid OIH expenses, 2. add the allowable amount, if any.

I decided that reimbursing the business part of the expenses that were more concrete sounded like a good plan. As Gary mentioned rent should not be done and I thought about it and it made sense not to have rent (if there were more dollars for rent than the expense on OIH then there would be income).

But in your opinion you think that the books should be just what is on the C then? That seems impossible not just for the OIH but also for auto mileage, etc. but I really think I have a mental block. And since I can't think it through, I am so happy everyone is helping!

[Gary2]

Keep in mind that bookkeeping for financial purposes is different than for tax purposes, and to an extent, different than for legal entity purposes. For example, there's nothing wrong with a business that is cash basis for tax purposes also maintaining accrual records for the sole purpose of better management and planning.

So from a financial perspective, there may be a justification in recording things that have neither tax nor legal entity implications. One could, for example, distinguish between an owner draw in lieu of salary from an owner draw in lieu of home office rent. Tax-wise, they're both just owner draws, with no tax implications (for an SMLLC - this wouldn't be true for a MMLLC). Finance-wise, it should give a better picture (instead of making it look like large income with no office space expenses). Liability-wise, my guess is no impact, but ask a lawyer. This gets into accounting, which puts those of us who aren't accountants at a disadvantage - I'm not sure of the right way to set this up within an accounting system.

I'm not surprised that a lawyer would pass tax questions off to the tax preparer. Many good tax attorneys aren't knowledgeable about which things go on which forms. But the same lawyer might easily give an answer if the question is phrased without reference to bookkeeping or taxes, e.g. "Should I pay my electric bill with two checks, write a separate check from the LLC to me to cover its share of the bill, or not worry about it, since I'll get to deduct its share regardless."

[oceanlovin'ea]

Piercing the veil???

I am not sure that there is an issue of "piercing a veil" with an LLC. If an corporation or s corporation does not operate like a corporation (having board meetings, keeping minutes, separate checking accounts, etc) they have pierced the veil and the corporation can be disolved.
But an LLC is not a corporation. There are no requirements for such recordkeeping. It is my understanding that the LLC (Limited Liability Company) is an entity that limits your liability. It does not have any requirements that have to be met. That is why people are choosing LLC's over S corporations. They don't have to worry about "piercing the veil".
So it would not matter what kind of accounting system is used to the state that set up the LLC. The difference would be in the choice of tax status. If one chooses to be a sole proprietor, then he would only be required to do what is required on a Schedule C. If he chooses to be taxed as a s corporation, he would have to keep a complete set of books.

Linda, EA

[oceanlovin'ea]

Beanna Whitlock

Beanna Whitlock does an EXCELLENT class on LLC's. She is with NCPE fellowship and does lecturing for NCPE and others too.

You can contact her through NCPEfellowship.com and she will answer questions about LLC's for you.

Linda, EA

[Jesse]

I think the issue of "piercing a veil" with a LLC is from a legal perspective and protection of any personal assets should any legal liabilities occur. I always suggest my clients seek the advice of a lawyer in regards to the liability protection and remind, that in my opinion only as I don't offer legal advice, there is no substitute for a good insurance policy to protect the LLC.

[Koss]

Original Post

The title of the original post was "Circular Question."

If a question isn't circular, then what type of question is it?

Square?

Linear?

Or something else?



BMK

[JohnH]

I've seen lots of question which were spirals.
After a few round trips, I came to realize I was actually in the middle of a tornado.

[JG EA]

Again - thanks to everyone for all your help.
By the way the only questions I like are the ones that have an intersecting line. (See the point?)