IRS publications say that the LLC is a disregarded entity for tax purposes. If I am a sole proprietor, I still continue to file a schedule C. There is a tax preparer in town that is telling profitable business owners to start an LLC to put the business building into and then have the Schedule C business pay rent to the LLC. It would appear that this is an attempt to avoid Social Security taxes because in actuality the business would be renting directly from the sole proprietor. I am trying to find something in black and white to settle this LLC issue, but what I am finding just doesn't seem to directly answer whether this is allowable.
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Ignore LLC
What IRS means about not recognizing an LLC:
The LLC must be either a partnership, corporation, or proprietorship, depending on filing and circumstances, so thus an LLC has not filing status of its own.
I believe an LLC with only one owner MUST be considered as a proprietorship. Someone correct me please if I'm wrong.
So the question is reduced to whether such rent is an allowable expense against the proprietorship, if the proceeds are paid to the proprietor. The LLC thus has no effect on the answer because it has been reduced to a proprietorship.
I'm a little fuzzy on this, and wish others would post their comments.
Welcome to the board, Sunny. -
A disregarded entity for federal tax purposes means for federal tax purposes, you disregard, or ignore its existence. So in the case of a single member LLC, its legal status as an entity is ignored. The LLC exists only for state liability purposes.
So in the case of a sole proprietor who also owns a commercial building, can the sole proprietor rent the building to himself, thus shifting self-employment income over to Schedule E, not subject to self-employment tax?
The answer is no. Forget the LLC part of the equation, because for federal tax purposes, it is ignored (disregarded). The same taxpayer cannot shift the character of income through self rental simply because it would not be a true landlord renter relationship.
The reason why you can do this in a corporation setting is because a corporation is recognized as a separate and distinct taxpayer from the individual.Comment
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Llc
A single member LLC is treated as a sole proprietorship for tax purposes unless an election is made to be treated as a Corporation. If it is treated as a Schedule C then I would think you could not do the renting thing (you can't rent to yourself). If it is treated as a Corp then I think you could do it. But the way you would do it is the owner of the real estate would keep owing the real estate and rent it to the corp.Comment
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You wanted something in black and white. I think this might apply. There are numerous ways you could in theory avoid taxes by doing similar things. There is something called the “step transaction doctrine” which has been used for years by the IRS to re-characterize a transaction so that the taxpayer cannot use the transaction to avoid taxes.
Rev. Rul. 79-250 defines the scope of the step transaction doctrine. It says: “The step transaction doctrine generally permits a series of formally separate steps to be amalgamated and treated as a single transaction if they are in substance integrated, interdependent, and focused toward a particular end result. The Internal Revenue Service has indicated on several occasions that threshold steps will not be disregarded under a step transaction analysis if such preliminary activity results in a permanent alteration of a previous bona fide business relationship. Thus, the substance of each of a series of steps will be recognized and the step transaction doctrine will not apply, if each such step demonstrates independent economic significance, is not subject to attack as a sham, and was undertaken for valid business purposes and not mere avoidance of taxes.”
The question then is, an individual renting to himself serves what business purpose? For what reason would a sole proprietor pay rent to himself for a commercial building that he also owns? The only reason would be the avoidance of self-employment tax, in which case I would think the IRS could employ the step transaction doctrine to nullify the tax avoidance result.Comment
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SE Tax
If he wants to avoid SE tax, an easier way would be incorporate and elect to be taxed as an S corp. Then pay himself part of the profits as a salary and pay SS, then the rest of the income would flow thru to him but would escape SS. Salary would have to be 'reasonable'.Comment
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Self-Rental
So, what is your opinion if we are talking about partnership LLC. One partner owns building with wife but wife is not part of partnership. Would it be different if partnership LLC is husband and wife? Or do the same rules apply as with Corp.?Comment
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