Forming LLC to avoid self-employment taxes.

I think you have two issues:

1) Is the LLC really a partnership for tax purposes?

See IRC 704(e)

2) If answer to #1 is yes, then is wife's share subject to SE tax?

The argument is that the wife's interest is "like" a limited partnership interest so she doesn't owe SE tax under

1402(a)(13). But legally for state law purposes she isn't a limited partner. She is an LLC member. So how will a court rule? We don't know. How will IRS rule? Again we don't know. The best we may be able to do is look at Proposed Regulation 1.1402(a)-2. However this proposed regulation (issued 1/13/97) will not be effective until finalized and after Congress told IRS to postpone finalizing them for a while nothing has happened.

Good luck!

-- Drew Edmundson, CPA Cary, NC

While the regulation is not finalized one would be hard pressed to deny that the proposed regulation represents treasuary position on this matter.

I read all the paper work the attorney prepared for the formation of the LLC and there is no distinction made between the husband and wife. Both can contract for the LLC and are equal in all respects.

What regulation? Are you speaking of an IRS attempt to give guidance as to what does or does not constitute SE income for those LLC members who are deemed partners?

Actually I sure wish they would do so. But so far IRS is in denial regarding the tax consequences of LLC's. Or so it would seem (grin)

ChEAr$, Harlan Lunsford, EA n LA

accountant.

justification

Why would the formation of an LLC do anything? It is a disregarded entity for federal taxation purposes.

Only single member LLCs default to disregarded entities for federal tax purposes. 2 or more member LLCs default to partnership treatment.

Here's my guess: What is the FMV salary for the husband? If it is

60k or more, then I think all of the 60k should go to him as salary, and he's have SS and Medicare on all of it. If the FMV salary is 50k, then he should get 50k as salary, and the remaining 10k should be distributions. If the LLC is taxed as an S Corp, then both husband and wife should get 5k as they each have 50% of the shares. But anyway, hope someone else knows better than me.

I would agree that it is unlikely that the IRS will disagree with the proposed regulations but we don't know for sure. Obviously Congress disagreed or they wouldn't have told IRS to put them on hold for a time certain (I don't recall how long the hold was but it expired a long time ago).

Did you resolve issue 1? What was your conclusion?

If you decided the LLC was a partnership for tax purposes then based on your additional information that she is able to contract on behalf of the LLC she would be subject to SE tax under the proposed regulation.

Some argue since the proposed regulation is not effective until finalized and Congress expressed its displeasure about the proposed regulation then the definition of a limited partner for SE purposes is open to interpretation. They then conclude that a reasonable interpretation is that an LLC member is enough like a limited partner that they qualify for the SE exclusion. There are large law firms all over the US paying their LLP/LLC members guaranteed payments for a portion of their income and then making the balance not subject to SE tax. I would be shocked if some large accounting, engineering, architectural, etc. firms aren't doing the same thing.

-- Drew Edmundson, CPA Cary, NC

D. Stussy asked:

Because there are other than tax reasons for forming an entity.

I know that sometimes we in the business think only in terms of tax implications and perhaps lose sight of more valuable legal reasons.

ChEAr$, Harlan Lunsford, EA n LA

Each should get equal salary just because they are equal owners? I would never recommend such to a client. Equal pay for equal work, yes; but not proportionately according to ownership. Whatever is left over, profits, is so apportioned.

ChEAr$, Harlan Lunsford, EA n LA

Both the taxpayer's accountant and myself agree that this is a parnership. I am of the belief that the wife should not have been made a member of the LLC in the first place. The attorney could have found other means of protecting the wife's interests beside making her a member of the LLC. (Mortgage on home used to finance purchase of business).

When I first found out that a two member LLC was formed my concern was that when the annual profit climbs to 200,000 (Which it will) both the husband and wife would have to pay the maximum amount of self-employment taxes on the profit. This future event would certainly shed light on why forming a two member LLC was a bad idea.

Well, the title of the thread makes it clear that the ONLY consideration was tax avoidance, but I don't see that at all....

Yes, but it's ALREADY a partnership, so what would recasting it as an LLC gain for tax purposes? I see none.

No, I did not say that each should get an equal salary because of equal ownership. Read again; I said that the husband should get all the salary, whether it is 50k, 80k, etc. This is because he did all the work. The husband and wife should get part of whatever's left over, if anything, in the form of dividends or distrubutions. If the LLC is taxed as an S Corp, then dividends are divided based on the percent shares you own; so each gets 50% of the distributions as each owns 50% of the company. If the LLC is taxed as another entity, even the distributions can be different for each party -- C Corps let you have different classes of shares. In any case, all this divisions of distributions doesn't matter if you file jointly.

According to the OP the LLC is a tax partnership so neither husband nor wife should get a salary. Not allowed under the law. Allowing partners to be put on payroll is actually on the Taxpayer Advocates list of things that should be changed.

-- Drew Edmundson, CPA Cary, NC

Generally, members of LLCs filing Partnership Returns pay self- employment tax on their share of partnership earnings. There is a special rule for members who are the equivalent of limited partners. They pay self-employment tax only if the LLC pays them for services (guaranteed payments)

More:

Milt Baker CPA

The wife is not a limited partner. According to the LLC's articles of organization she can contract on behalf of the LLC and has the same rights as the husband.

Ordinarily would go read that link, but... it looks suspiciously like a link to the NOo Yawk Times. So guess I'll pass.

ChEAr$, Harlan Lunsford, EA n LA