Speaking of corporations

[Black Bart]

A "maybe" client -- age 62; receiving social security -- formed LLC as a sole proprietor last summer. Has no '06 income, but '07 earnings will exceed max allowable earnings and reduce SS benefits. Wants to switch it to an S corporation and draw $12K salary out of estimated total of $20K income and put remaining $8K on K-1. Sounds okay to me. He applied for a federal ID number, listed no employees, and IRS isn't sending him any 941 forms to fill out.

Questions:

1. There's no income, but would his ID number app prompt IRS to expect an '06 tax return? It told them he intended to do business, but he didn't and since IRS disregards LLCs and nobody's sending him any 1099s, it doesn't look to me like a return would be necessary for the year.

2. Should he dissolve the LLC at state and form a new S corporation? It's my understanding that it's okay to have an S coporation inside an LLC, but what's the advantage? Does the combination of an S corporation and an LLC give one "double" liability protection, which, aside from salary and SE issues, is usually the reason for forming these things.

3. If he keeps the LLC and incorporates it for '07, should I then (after submitting an S corp election) simply file a correction of the app changing entity type from sole prop to S?

[veritas]

Hey BB!

1. Should be no problem. Nothing needs to be filed.

2. If the sole member of the LLC files form 2553 you will elect to treat LLC as an S Corp. This can be done effective 1-1-2007.

But to make things simple could prospective client accelerate some of 07 income into 2006? This would sure alleviate alot of paperwork.

Good to hear from you again!

[Snaggletooth]

No No No

This is clearly a contrivance, and IRS would bust the scheme on that basis, EXCEPT:

...the law allows the IRS to redefine salaries, etc. dates, etc. even marriages, IF they determine that the device serves no other purposes than to avoid tax.

HOWEVER, (and this is the big question) what if the avoidance is not tax but rather a reduction in SS benefits? Do the regulations give the IRS the same sweeping power?
The taxpayer regards both the IRS and SS Admin as "Big Brother" but are these two agencies the same with regard to the issue above?

More discussion, please....

BB good to hear from you - Snag

[veritas]

Snag who are you saying no no no to?

I could do what BB proposed and get away with it all day long. Do you think the IRS or anybody is going to worry about a few thousand dollars that no fica tax was paid on? The government gets it's FICA tax on 12,000 and as a bounus gets FUTA tax. The state wins too because they get SUTA.


That being said I was trying to suggest some alternatives. If it was my client we would probably not go the SCorp route. Who knows maybe a C Corp would be better anyhow. Let's see what OldShowme has to say.

[Snaggletooth]

Don't Know

Veritas "Thy Name is Truth" - I'm anxious to hear from Old Jack as well on this one.

Bart's issue is not whether IRS collects taxes, but rather whether social security is going to "dock" his client's SS benefits by 50% of the excess over $12,800.

If this were deemed to be a scheme to dodge taxes and the amount was substantial, IRS would declare this to be a contrivance with no benefit to the taxpayer other than the avoidance of taxes. I agree that the amount of taxes is of no consequence and they wouldn't waste their time on it, although they might be interested in more SE tax.

However, what if the "real" earnings was $30,000 and salary of only $12,000 was paid? At issue is not income taxes but social security benefits. Hmmmm - $30,000 minus $12,800 is $17,200. Social Security would reduce his benefits by half - $8600.

The question becomes, "Can (or will) the IRS declare a contrivance when expenses pertaining to another agency (other than IRS) is affected?"

[Black Bart]

Veritas & Snag

Gomer says "hey"! Nice to be back, guys. Thanks for the quick replies.

Veritas: You're thinking like I am about the return -- I can't see any reason that merely filing for an ID number would create any obligation to file a "no operation" tax return. Negative on the pulling of income back into '06 -- nothing's been made and won't be 'til '07.

Snag: I agree that's it's an obvious contrived situation (it's to kill off the payback of social security benefits here), but I agree with Veritas that it's pretty much low-risk, as I've seen it done many times with no kickback. I suppose they could make a "federal" case out of it by reclassifying everything and it's kind of an interesting question you raise as to whether IRS or SSA would take precedence, but I don't believe either would bother much with this case.

I'm really not that concerned with audit-risk factors or the endless "reasonable salary" question, but rather I am much more interested in the question of why people form S corporations and also make them LLCs or they form LLCs and then also make them S corporations. I know other people do that and I don't mind doing it (it's not that much extra trouble) but I'd just like to know why it is done.

[Snaggletooth]

Lawyers

Bart I think the answer to "Why" we've got LLCs is because they are the "Next Big Thing" for lawyers. It's like changing styles in a women's dress shop, or buying ties for Dad at Christmas. These things are created so the sellers can have something to be excited about. LLCs are invented, blessed off by the state, and [poof!!!] instant entity to be peddled whether there is any substantial difference or not.

The smart tax gurus who post here (certainly not me) have confirmed time and time again the IRS doesn't recognize LLCs for tax purposes, and those who choose to create an LLC must file as some other recognized entity.

[geekgirldany]

S-Corp & LLC

I think LLCs just cause more confusion for the taxpayer/customer. Had a new customer come to me a friend told him "file your business as a LLC. You'll be protected by the liability". He goes online to incorporateme.com or some place and they fill everything out for the LLC. Gets him a federal ID number and because the LLC has two members... hey it must be partnership. So the IRS is now looking for a partnership return.

He then goes to the prior CPA that tells him

"you need to be a s-corporation".
"but I'm a LLC"
"well you want to be a LLC and be taxed as a s-corporation".

So the customer not the CPA takes care of the notices from the IRS. Tells them he wants to be a S-Corp. Thankfully this customer is pretty smart and filled out the 2553 right.

But to put it plain... the customer/taxpayer doesn't know any better. If they go their CPA, EA, taxpreparer first and ask I'm sure (or atleast I hope) they will tell them the benefits of being a S-corporation and then the benefits of being a LLC. The only reason I see for one becoming a LLC is if they are a partnership or a sole prop. Then comes the question how reliable is LLC liability?

[outwest]

I've used a LLC sometimes for this reason alone..

for some people it reinforces the idea that they have a business side and a personal side. and you can't pay personal groceries out of the BUSINESS!

Of course, here in Idaho, a one page form, $100 to file, a SS-4, and a postcard to the secretary of state each year is all it takes. No change in the tax return. I'd think a lot harder in California for instance.

As far as liability, 1. Be careful and honest out there. 2. Buy insurance. 3. as a last rock to throw at the hordes storming the castle, a corp or LLC.

Doug

[Black Bart]

Dueling entities

the prior CPA...tells him

"you need to be a s-corporation".
"but I'm a LLC"
"well you want to be a LLC and be taxed as a s-corporation".

...the customer/taxpayer doesn't know any better. If they go their CPA, EA, taxpreparer first and ask I'm sure (or atleast I hope) they will tell them the benefits of being a S-corporation and then the benefits of being a LLC. The only reason I see for one becoming a LLC is if they are a partnership or a sole prop. Then comes the question how reliable is LLC liability?

Hi dany / Thanks for your input. As Snag said above, many lawyers (and some of us tax folks also) do it for the money and, too, it's kind of a trendy thing among customers these days. I've had several clients say they heard Joe Blow "is an LLC" and "I want to be one too, because those initials sound even better than INC after my company's name." That's the depth of thought that goes into some of these decisions occasionally.

I've made LLCs out of a couple of sole proprietors that wanted lawsuit protection, but didn't want the hassle of filing a 1120 or 1120S. This made them feel better, but I've read that that the LLC "protective veil" isn't that strong for sole proprietors because one can't escape from the consequences of his/her direct acts and also there's nobody else to blame as there would be with 1065/1120/1120S.

I can see how the personally liable partners in a 1065 would want to be an LLC, but an S corporation already has limited liability. I wonder how much more coverage against lawsuits an LLC would add to the existing S corporation protection?

[rosieea]

I believe the liability protection issue is largely a matter of state law. In my area, lawyers are urging clients to form LLCs rather than corporations, because they feel that the LLC offers stronger protection.

[jimmcg]

Theoretically an LLC and S Corporation offer limited laibility to the owners. However this is always subject to court interpretation at the state level. It has been my experience that the major benefit of the LLC over the S corporation is in their flexibility of organizational structure. The LLC at the state level is still in it's infancy as to state court interpretations and rulings and time will tell.

[jainen]

the limits of coverage

Although there seem to be a lot of lawsuits going on these days, the liability shield of an LLC or a small corporation is vastly overrated. For one thing, as BB points out, if you do something personally you are personally responsible for it, even if the company that employs you is also named as a defendent.

A major consideration is the degree of harm your business could cause. For example, most tax preparation malpractice claims only relate to Penalty & Interest of less than $25,000, and you have plenty of control over the events that lead up to and past a claim. Compare that to the risk exposure a pizza parlor has with stoned losers speeding around in broken-down cars trying to beat the 30-minute delivery deadline!

Another factor I rarely see mentioned is--what have you got to lose? These entrepreneurs have usually hocked everything and maxed out their home equity to (under)capitalize their latest project. Any plaintiff would soon find out his lawyer is going to strip HIM clean, because the defendent doesn't own anything! And since the business will most likely fail within a year or two without ever turning a profit, all the trouble of incorporating is wasted.

The most important part of insurance is not that it will cover liability. It is that the insurance company will bring an insurance lawyer to the case. That in itself will usually scare away most claims, or at least force a settlement for the limits of coverage.

[Unregistered]

One of my s-corp clients, over 65 tried this. The SSA interrogated him for hours wanting to know what his job duties were, how many hours a day did he work, etc. The only thing that saved him was that there were other S/H's who pretty much ran the business. My client truly was in the retirement mode.

[Unregistered]

The previous post is from Dsi.