I have two brothers who recently started selling a product through a multi-level co. They want this venture to be a partnership and have done everything to set it up as such. They've done a dba, opened a bank acct. to which they deposit all income, pay all expenses and take equal draws. The problem is most of the income comes from the parent co. made out to each brother and I'm sure they will be receiving 1099's as individuals. What is the best way reconcile the 1099's with the partnership return so the IRS knows that the taxes are being paid properly on the net income.
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Why does everyone worry
>>What is the best way reconcile the 1099's<<
Why does everyone worry so much about 1099's? You're not issuing them, so it's not your problem if they are wrong. Report the income correctly, and if the IRS has a question you can answer them.
My only concern would be that, since the parent company won't change the tax id number, maybe what your clients are telling you doesn't reflect their true relationship to others within the multi levels. -
I disagree.Originally posted by jainen View Post
I think issuing a 1099 to the wrong person is something to worry about. There are rules against assignment of income to another taxpayer, and if the 1099 says the income was earned by an individual and not the partnership, you’ve got a problem.
If the brothers want the partnership to recognize the income, the deal with the parent company has to be made through the partnership, not through the individual partners. If the individual earned the money, per the company agreement, then the individual must report the income. You can’t just assign the income to the partnership.Comment
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something to worry about
Thanks, B. I agree with your disagreement. That's EXACTLY what I was trying to say, only as usual I started out in the wrong direction and never got straight.Originally posted by Bees Knees View PostComment
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This is exactly how I see it as well. The first thing I did was have them apply for an EIN for the partnership and they will ask the the parent to send the 1099s to the partnership or to each partner doing business as the partnership. My second thought was why not just do two sole proprietorships and adjust the income and expenses with a 1099 for commissions to equalize the net income. This would be almost completely unmanageable. The fact remains that the two brothers are truly a 50/50 partnership in every aspect except they will receive 1099s for unequal amounts. My last thought (which I would love opinions on) would be to create a set of books showing all the expenses and then attribute the expenses to each sole proprietorship on a precentage basis in direct correlation to the incomes. Any thoughts?Comment
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The assignment of income doctrine
function is to prevent the person earning the income from transfering it to someone else, thereby avoiding taxation.
Your brothers-in-arms don't seem to be attempting to avoid taxation, rather they wish to pool income and expense and divide the net income equally.
I have insurance salesmen that have incorporated but still get their income reported on 1099's. We attach a list of the forms and list the name and EIN of the corporation where the income was reported. Once in a while we will get a matching notice. Once we send a copy of the list and a letter of explanation the IRS has always closed the inquiry.In other words, a democratic government is the only one in which those who vote for a tax can escape the obligation to pay it.
Alexis de TocquevilleComment
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Your insurance salesman who incorporates his business is not the same thing. I too have had corporation shareholder’s who were issued 1099s report the income on their corporation return, as the income clearly belonged to the corporation and not the shareholder.
In this case, however, we have two related parties…brothers….who for some reason want to divide income and expenses evenly, even though they apparently are not going to generate equal income. The IRS could very well decide that one brother is attempting to shift income to the other, especially if the one brother earning more of the income happens to be in a higher income tax bracket.
It may not be an issue if the partnership would in turn pay a guaranteed payment to the partners in proportion to the income they individually generate for the partnership. But if there is no guaranteed payments, and the brothers truly want to divide the income 50/50, they need to have the payer make the work contract be between the partnership and the payer.Comment
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"Always"
>>the IRS has always closed the inquiry<<
"Always," as in repeatedly? How many times has the IRS questioned this arrangement?
Your example shows that although there may be a valid way to do it, on the face of it there is likely to be a problem. In spite of my earlier post about 1099's, you can't assume it is wrong just because it doesn't say what you want it to.
Multi-level marketing is based on personal contacts, and the company may not permit other business entities in the middle. In that regard it isn't just a matter of assigning income. The company has to agree to assign the contract.Comment
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Points well taken
Bee's I had in mind to add some line about equal GP's relative to income to my previous post.
Jainen in answer to your post, I didn't assume your post to be wrong. Your tax knowledge is impressive. The arrangment has been questioned no more than once on each return with this general arrangment. I use insurance because it's the most comman return I see this on. I've had notices on a golf pro, plumbers and MLM operators too.
The plumbers are in fact most like the brothers in this case. They are not my clients but I answered the notice since the preparer was not an EA. They are unrelated but they share the business 60/40. They keep a single set of books and split income and expense onto two schedule "C's". All 1099's are reported to the 60% partner. After nearly 20 years of this arrangement the 60% partner gets a CP2000 asking about the income not reported on his return and accessing $30K or so of tax.
I had a really bad feeling about the situation since they clearly should be filing a 1065. I obtained a power of attorney for both partners, explained the situation just as I am now, sent a copy of the 40% partners return and a worksheet showing the split. Much to my surprise we received a closing notice in about 3 weeks.
I'm not saying it's correct, not by a longshot, it is however a real world result. Does the substance out weigh the form? All income and expense was correctly reported and all tax was paid. It would seem that at least one IRS agent agreed.In other words, a democratic government is the only one in which those who vote for a tax can escape the obligation to pay it.
Alexis de TocquevilleComment
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Thank you David as well as the other posters. Your post in particular helps. I have learned that the partnership return will not work but a corp return might. Incidently, equalizing the two incomes will probably cause a slight increase in taxes paid by the two brothers not the other way around. I still have the option to have one brother give a commission to the other for services rendered to achive their goals but that will cause a number of bookkeeping headaches.Comment
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True Partnership
I once went 'round and 'round with a tax expert (meaning someone obviously more knowledgeable than myself) about the necessity of forcing people in a casual relationship to file a partnership return. In fact, Armando may be still lurking around in the shadows, and whispering "I told you so..."
The situation you describe is a true partnership, set up to be 50:50. That means beginning capital (no matter how meager) must ultimately be 50:50, and distributions of income must be 50:50.
These are two of the most quarrelsome issues in a partnership and can easily cause one to break up. One partner feels like he has put up too much of the money, or one partner feels like he is doing all the work, and squabbles begin. Disparities in capital can be avoided by the lesser contributor creating a loan, thus "subscribing" capital (a GAAP solution which doesn't necessarily fly for basis) . And for income, I emphasize 50:50 because some have suggested an "equitable" arrangement instead of an "equal" arrangement.
Disparities in workload/sales productivity in this case should ideally be recognized by some sort of compensation arrangement whereby the partnership issues payments for services and/or sales. These payments are not the same as "distributions" described above, because the 50-50 payment should be for partnership income left over AFTER compensation has been paid. And yes, each partner should receive a 1099 for his respective share of this compensation, as well as a K-1 for 50% of the income left over whether distributed or not.
The 1099s will force each partner to file a schedule C for this compensation PLUS the 1099s issued by the parent company, and revenue will thus be overstated. However, the excess revenue can now accommodate an expense showing "commissions" without distorting the schedule C. In conjunction with the commissions, each partner can now issue a nominee 1099 to the partnership for the exact amount of parent 1099s.
The long-term answer to the 1099 from the parent is to agree for the parent to make their checks out in the name of the partnership, no matter which partner made the sale. I don't think you will see any relief from personal 1099s until this happens. A successful selling venture will go a long way in convincing the parent.
Apologize for the long post, and if I've covered some material that you already know, please disregard.Last edited by Corduroy Frog; 06-14-2007, 01:29 AM.Comment
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What you describe here is a guaranteed payment. See the example in the upper left column of page 20-5 in TTB.Originally posted by Corduroy Frog View Post
And no, the partnership does not issue a 1099 for such payments to partners. They are reported to the partner on line 4 of the partner's K-1.Comment
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Uncertain Compensation
Bees, does such a compensation payment qualify as a guaranteed payment even though the amounts, splits, etc. are subject to ongoing external forces such as sales, time spent, etc.? Just asking...as no specific amounts or percentages are effectively "guaranteed" by partnership?Comment
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if you were the auditor
Thanks again for your opinions. This is how I think I will have them proceed. The brother who will be receiving the larger annual income will 1099 the second brother for services rendered thus creating equal incomes. All income is deposited into a joint account and all expenses including draws are paid from that account. To my way of thinking this creates a "joint venture" not a tax entity. Since all expenses are paid from this account we would file to identical sch Cs, one for each brother. This "joint venture" has it's own name, checking account and business license. This entity will have an agreement drawn up and notarized showing their intent. A small percentage of the income from retail sales will be from checks made out to the joint venture but I can even have them change that. My question is what would you do if you were the auditor? Do you see a flaw in this approach?Comment
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Yes, in fact, that is exactly what a guaranteed payment is. TTB says:Originally posted by Corduroy Frog View Post
Guaranteed payments are payments made to partners without
regard for the profit of loss from partnership activities. Guaranteed
payments are deducted from partnership income in determining
the distributive share of income or loss passing through
to partners.
Guaranteed payments are the equivalent of wages for a shareholder-
employee of a corporation. Guaranteed payments are
generally based on services rendered, rather than a percentage of
partnership income. The flexibility in providing guaranteed payments
allows a partnership to compensate partners for different
levels of service without requiring special allocations.Comment
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