Downside of LLC electing S-Corp status

[jrumbold]

Insurance agency is an S-Corp. They have decided that they want to take out profits (not subject to SE tax) based on the production of each agent, i.e. not in proportion to shares owned. I am advising them to switch to LLC taxed as an S-Corp. This will also eliminate the problem they have with not keeping corporate records.

So, as I see it the LLC lets them create a formula in the agreement to share profits based on production of each agent. (They are each paid a salary anyway.) As a result, the profit sharing percentage would change each year. Because the entity is taxed as an S-Corp there is no SE tax on the profits.

What are the downsides of making the S-Corp election for an LLC? I have not be able to find any.

[jainen]

terminating S-status

>>the profit sharing percentage would change each year<<

I believe this would constitute multiple stock classes, thus automatically terminating S-status.

[JoshinNC]

agree with Jainen

this is one of the benefits of LLC/partnership taxation over S-corp is the ability to define multiple arrangements for compensation that do not run amock (is that the right spelling?) of the 1 class of stock rule

[George Boutwell]

It's Amok

this is one of the benefits of LLC/partnership taxation over S-corp is the ability to define multiple arrangements for compensation that do not run amock (is that the right spelling?) of the 1 class of stock rule

But how do you solve the SE tax problem, which was the original reason for the question?

[Roland Slugg]

Honor the stock ownership ratios

Dear jrumbold

All pre-tax payments ... i.e. payouts based on production ... should be treated as compensation, reported on forms W-2 (or 1099-MISC), and deducted by the S Corp on its tax return. The after-tax distributions should be treated as dividends and should be made in strict proportion to stock ownership. The production payouts will, of course, be subject to FICA or SE tax, and if this leaves little or no income to flow to the shareholders via the K-1s, then no SE tax will be saved.

[jrumbold]

LLC Stock??

I must respectifully take exception with jainen and Roland. This will be an LLC and as such it will not have any stock. It will only have members. So, I don't quite understand why some are saying the profit distribution needs to be in proportion to stock ownership. There is no stock ownership in an LLC. The membership agreement will contain a formula for distribution of profits. Also, just to clarify, the profits or "production" is not the commission that the agency earns from insurance policies. It is the bonus payments that the principle firms send to the agency when certain goals are met.

[rosieea]

I must respectifully take exception with jainen and Roland. This will be an LLC and as such it will not have any stock. It will only have members. So, I don't quite understand why some are saying the profit distribution needs to be in proportion to stock ownership. There is no stock ownership in an LLC. The membership agreement will contain a formula for distribution of profits. Also, just to clarify, the profits or "production" is not the commission that the agency earns from insurance policies. It is the bonus payments that the principle firms send to the agency when certain goals are met.

Once an LLC elects to be taxed as an S Corporation, it must follow all the rules pertaining to S Corporations. It cannot pick and choose. Members must be treated as if they own stock in proportion to their membership percentages. Disproportionate distributions will be treated as tantamount to creation of a second class of "stock" and will terminate the S Election. Remember that an LLC is an entity recognized only by the state. There is no such federal animal. If the LLC has elected to be taxed as a corporation, then, in the eyes of the feds, that is what it is.