Advising On Partnership or S-Corp

[geekgirldany]

I have a client that is wanting to bring her sister into the business. It is currently an LLC taxed as sole prop to Sister 1. Sister 2 is providing more services for the company starting in January 2014 and Sister 1 feels it is only right that she have a stake in the company.

I have advised them to go S-Corp as if something was to happen between them and one left then the business could continue. Sister 1 says currently they would not be able to afford payroll taxes throughout the year and that is the main obstacle of doing an S-Corp. She has spoken of turning the LLC into a Partnership. I told her I would not be able to help on a partnership return as I have not prepared one in years and prefer not to. That they would have to go to another accountant. The client said they really want to stay with me.

Sister 2 has started providing services to Sister 1 company but also does the same kind of work for other clients. I suggested that as an option Sister 1 could 1099 Sister 2 as a subcontractor since she is really already doing this service for other clients. It is just that a majority of the income will come from Sister 1.

Was the advice on the 1099... well, sound advice? To me it seems like a good option until they can turn into an S-Corp.

Also isn't there additional rules for family members in an partnership together?

I could prepare a partnership return, I did many years ago, but things can sometimes get sticky and so I really do not like to get involved with them.

Thank you for any help.
Dany

[ATSMAN]

I frequently get asked questions regarding business ownership, entity formation etc. In each case I tell them I am not an attorney and they should really get sound legal advice. I have an arrangement with a local law firm and I refer them.

Having said that from a tax perspective I would be very careful suggesting a 1099-misc sub-contractor position to a family member that will be working in a store front, taking work supervision from the owner. There are countless IRS examples why this will not generally fly. A misclassification could cost your client dearly.

I think a 2 member LLC may make sense. Obviously they will have to decide either file as a partnership or a sub-S.

In my state LLC and Sub-s pay the same franchise tax so from that perspective it is a wash. I have a few convenience stores owned by siblings that file as LLC. These clients often ask me that they want to pay their counter girl a 1099-misc??

[mastertaxguy]

Small Business Tax Book has, tab 31, has some guidance on the overall issue.

[geekgirldany]

Yes, I was hesitant on the 1099-Misc but I thought since Sister 2 does provided the same service to other customers and receives the money directly from them it might be okay. The checks are written to her not the LLC. It is just that the majority of the income she gets will be from Sister 1 LLC. Really the only supervision that Sister 2 will have is to tell her what job needs to be done that day. She sets her own hours. I'll have to think about it and call them back.

I know TTB goes over very much about partnerships but there are many on the board that are preparing them regularly and may provide some insight that is not covered.

[ATSMAN]

What kind of work does sister2 do? Perhaps that may give you some idea if an independent contractor status may fly?

I can tell you now that if this is a retail establishment where she is dealing with customers from the store location, using the owner's supplies and equipment it will not fly.

[geekgirldany]

She would not be dealing with customers but would be using Sis 1's supplies. I talked to them this evening. I told them I felt like with so much income coming from the LLC business that Sister 2 is really not a subcontractor.
They agreed and had already come to the same conclusion. I told them that they really do need to become a partnership but will need to work out a partnership agreement and highly suggested getting an attorney involved to make sure it is correct.

I am also going to prepare the partnership return. I usually run from them but I feel comfortable in dealing with these sisters. I had a bad experience with a partnership years ago... I just need to learn that not every single one is going to end up in disaster. Going to have to brush up on my partnership preparing "skills"

[ATSMAN]

One thing to watch out for in these partnerships where the partners are family members is to keep detailed records of what they contribute to the partnership in property and cash. I had one hell of a time sorting things out for a Plumbing LLC where 2 cousins joined forces and did not keep good track of what they brought to the partnership. That is required to calculate their basis, based on accurate FMV. They agreed 50/50 but at the end it was more like 80/20 based on basis.

[jsamans]

...they really do need to become a partnership but will need to work out a partnership agreement...

Though it's true that the resulting entity will be taxed as a partnership, it will actually be a multi-member LLC and therefore will have an operating agreement (rather than a partnership agreement) as its governing document. Some of the terminology in an operating agreement is different, so it's good that you've referred them to an attorney for guidance.

By the way, you're probably aware that an LLC can file Form 8832 to specify how it will be taxed. My understanding is that, once filed, this form locks in the specified tax structure for five years. If their goal is to eventually move to corporate taxation with subchapter S pass-through, they should not file the Form 8832. By not filing, their MMLLC will be taxed as a partnership by default.

I'm mentioning this because I've seen folks who filed the 8832 to specify treatment as a partnership, "just in case," and then realized after a few years that they would've been better with corporate taxation. They had to wait the full five years, whereas they could've converted right away if they had not sent in the form.