LLC and SE earnings revisited

[equinecpa]

What would you do with the following case:

LLC has ordinary Business Income $200,000

Facts: Husband and Wife are the sole 2 members in the LLC, 50/50.

Husband involved in operations of the LLC (though not on a daily basis since he lives in another state ). Wife has very little involvement maybe a few hours each month. LLC's daily operations overseen by an employed manager.

I'm thinking there might be room for an argument that these earnings are not subject to SE taxes. I don't believe they have a written operating agreement, and don't have any kind of guaranteed payments.

If this were an S corporation I'd have no qualms not paying the wife a salary, and only paying the husband a salary of approximately $50,000.

Do I have enough suport to report as guaranteed payment $50,000 for the husband and then exclude all the other earnings from SE taxes? I do intend to discuss this issue with my client as I understand it's a bit of a controversial issue. This client is agressive when it comes to tax reporting.

I'm considering recommending that this client file an S corp election going forward, pay a salary and then not have to worry about this issue. But for 2006 I'm just not sure what to do...

Thanks for any input.

Carolyn

[Barnett]

Re: LLC $ 200.000

your $50,000, figure appears arbitrary and most decidedly should be discussed with your client . He is the one the IRS will seek for confirmation , the rules of SE should be followed.
Your notes exclude all other earnings from SE taxes ? should be decided on the basis of employment agreements .ie , master - servant.
Paying the Husband $ 50,000. would need substationated.

[taxmandan]

Justify the amount

You need to justify the amount subject to S/E tax. $50K may or may not be defensible to the IRS. What is the reason for that amount? You might go to www.salary.com and determine what would be a reasonable amount for what the husband is doing in the business. Might be more, might be less than the $50K. Just don't pull a number off the ceiling, have some validation of why that amount is reported for S/E tax.
As for electing S-Corp status, I wouldn't recommend that just for this reason, you can handle this just fine in the LLC. Don't burden the client with additional payroll reporting, etc. when a little work can take care of this matter. Besides, theIRS is aggressively auditing S-Corps right now for this very reason and they are reclassifying income across the board, may be a fight your client would prefer to avoid. Partnership returns are the lowest audit rate in theIRS, something to consider.


Daniel

[JoshinNC]

I wouldn't report any as subject to SE tax

What would you do with the following case:

LLC has ordinary Business Income $200,000

Facts: Husband and Wife are the sole 2 members in the LLC, 50/50.

Husband involved in operations of the LLC (though not on a daily basis since he lives in another state ). Wife has very little involvement maybe a few hours each month. LLC's daily operations overseen by an employed manager.

I'm thinking there might be room for an argument that these earnings are not subject to SE taxes. I don't believe they have a written operating agreement, and don't have any kind of guaranteed payments.

If this were an S corporation I'd have no qualms not paying the wife a salary, and only paying the husband a salary of approximately $50,000.

Do I have enough suport to report as guaranteed payment $50,000 for the husband and then exclude all the other earnings from SE taxes? I do intend to discuss this issue with my client as I understand it's a bit of a controversial issue. This client is agressive when it comes to tax reporting.

I'm considering recommending that this client file an S corp election going forward, pay a salary and then not have to worry about this issue. But for 2006 I'm just not sure what to do...

Thanks for any input.

Carolyn

If they did not take GP (same or similar payments from the company on a specified schedule irregardless of the profits of the company) then the earnings don't meet the requirements for being subject to SE tax under the code. The S-corp argument is crazy. The IRS is already putting S-corps under more scrutiny, but not LLC's (at least not yet).

If the client is aggressive let him be aggressive. You're job is not to make the decisions for the client. You are an advisor. Give him both sides of the issue, all possible benefits and pitfalls, document your discussions and allow him to make the final decision.

Aggressive and illegal are all too often confused with each other. Don't do your client a disservice by letting him pay more tax than he is legally liable for.

[equinecpa]

I have actually emailed this client the lengthy thread on this board on this subject. I do think the S corp is a good idea this company has payroll so it wouldn't be an added burden.

I have also offered another alternative to the couple - record a large guaranteed payment (there were some substantial withdrawls on capital this year that could be called guaranteed payments), put husband over $94,200 and therefore reduce wifes SE income to minimal.

JoshinNC -I've seen all the discussion back and forth on this subject. This was formerly a partnership that went the LLC route a few years back. I'd think it would be hard to argue that NONE of this income should be self-employment earnings? The husband earns a portion of his earnings, they have guaranteed debt etc. I could see a portion of the husbands earnings being considered a ROI so therefore limited partnership income along with the wifes, but I don't see the husbands falling all into that category.

Carolyn