There's a single member LLC. The member is married, but his CPA recommends that he be the sole owner so that his wife won't be required to pay self employment tax on her community property share of the profits. Apparently it's taxed as a sole proprietorship. There previously was another member (not the spouse), and it was taxed as a partnership.
The LLC will be transferred to a revocable estate planning trust. The husband will no longer the the "member" but will be the sole employee.
Is there any potential problem here? I have the feeling I'm missing something.
Thought someone would chime in on this one. Partners and sole proprietors are not employees--he should not pay himself a wage. Yes, the default will be as a sole proprietorship since the LLC did not elect to be taxed as a corporation.
I had been thinking about that also, but the phrase "LLC will be transferred to ... a trust" is sufficiently vague as to cover a couple of possibilities as to type of entity.
But in the base case, if nothing else is done, it seems to me that the individual will still file Schedules C and SE for this business, but that profits of the business and possibly capital equipment will be given to the trust. Since it's a revocable trust, there is no gift tax unless/until that changes.
I am not sure what the trust's tax return would look like, but I don't think that's a major issue.
What's vague about transferring legal ownership to a revocable living trust?
If the owners are not necessarily the employees, why would a wife's ownership require her to pay self employment tax if she's not an employee? After transferring to the trust, does it make any difference if the wife is a beneficial owner or if beneficial ownership must remain with the husband to avoid the wife paying self employment tax?
Going back to the OP's post, the spouse does not pay self-employment tax because she is not a partner (which they were advised against doing).
Were she a partner, she would pay SE tax on her partnership income. (At least under many circumstances.) But that is not the case here, it's a sole proprietorship.
As I see it, were it a non-revocable trust, but with wife as beneficiary then there would still be no gift tax (spousal exclusion), and the husband as sole proprietor would still have to pay all the self-employment tax himself.
Interested if there are other possible interpretations.
My problem is that this is California. Wife is an owner through community property. If it gets transferred to a trust, it would be difficult to keep technical ownership away from her. So if it's in a trust, must she then start paying self employment tax because she has an equitable interest?
This is interesting, but I still think that only a worker or a partner ever pays self employement tax. Owners of sole proprietorships pay SE tax because they are workers, not because they are owners.
So their accountant was wrong? He said that if the wife became a partner, even a non-working partner, then she would be subject to self employment tax.
I confess I was hanging back from answering too, like Brew1.
Stu, I have never heard of community property & income rules applying to self-employment tax. Even when splitting income and deductions for a California married couple on MFS returns, the FICA (SE) portion is not allocated 50-50, each spouse retains their individual earnings record and taxation for Soc. Security purposes. This applies to wage income, and I can't see why it wouldn't apply to Schedule C income also.
As for the revocable trust, I defer to you on the legal aspects, but I've always understood that a grantor revocable trust is disregarded for income tax purposes.
Agree with others, this maneuver (moving LLC to the revocable trust) does not suddenly make him an employee.
I don't understand the problem -- why is the spouse even being considered for membership in the LLC?
Yes, I understand that. The issue has to do with ownership versus taxation. If an owner of a partnership or LLC is required to pay self employment tax whether he performs services or not, it's possible to have one spouse technically be the owner of a company that is, in fact, community property.
But once it's transferred to the trust, as community property it's technically owned by both spouses. So I'm worried about avoiding self employment tax for the wife, who does not work in the business and has not been a technical owner up to this point.
She's not. But if the LLC is owned by the trust, can it still have only the husband as a sole owner, even though it is community property and not technically owned by the husband but by the trust?
I don't see why not. If the LLC is not owned by the trust, and it is still community property, the husband can be the only one who has to pay SE tax. See instructions to Schedule C re Husband-Wife businesses. So, if the grantor trust is disregarded for tax purposes, disregard it.
I believe the accountant was right: a LLC, absent any election of, or act of, incorporation, is taxed as either a sole proprietorship or a partnership. If it's a partnership, all general partners pay self-employment tax on their distributive share of partnership income. This is why in the above I said "only a worker or a partner ever pays self-employment tax", which I think is the 95% answer to the question of who must pay this tax.
In the above sentence you conflated "owner" with "partner".
It already was community property.
Even if it isn't transferred to an LLC, she is an owner of her husband's business in a community property sense (unless the business existed before the marriage, or is excluded by pre-nups/post-nups, etc.). But owner does not mean partner.
Ok this may be where my problem is. From a legal standpoint you can't be a partner (we're talking general partnership here) unless you are an owner, and you can't be an owner unless you are a partner.
While there may be equitable ownership by virtue of community property, legal ownership can be in one spouse, and the other doesn't need to pay self employment tax.
But are there circumstances where a general partner does not need to pay self employment tax? If the other partner takes all the proceeds as compensation for his services, does that work?
distributions do not have to be according to % of ownership. If the partners agree, the person doing the work could take all the profits as a guaranteed payment, leaving no S/E income for other partners.
An operating agreement can stipulate unequal percentages of profits allocated to the partners (um, members, since this is an LLC), regardless of the capital contribution/ownership breakdown. See, e.g.
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But it does not seem to me that guaranteed payments will work. Guaranteed payments are the partnership equivalent of salary, and are generally fixed amounts. See, e.g.
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"Generally, guaranteed payments are payments made to the owners other than in their capacity as owners and _without reference to the LLC's earnings_." Like a company with employees, the guaranteed payee get paid regardless of whether the company makes a profit, or how much.
"For example, if an agreement provided that one owner in a two-owner LLC was to receive a 'salary' of 50% of the LLC's earnings, with the other
50% allocated to the other owner, this 'salary' would be unlikely to constitute a guaranteed payment."
With the caveat that there is more than one way to skin a cat, here's my take.
The rules are still unsettled on the taxation of an LLC - remember, it is ALWAYS a disregarded entity, it has no tax return form of its own. By default it files either a 1065 or a Schedule C UNLESS it elects to be treated as a corporation.
Way back in the '90s the IRS tried to treat LLCs filing 1065s as General Partnerships, treating the pass through income to all members as being subject to SE tax (IRC 1402). America rose up, congress backed down and issued an order to the IRS to NOT assess SE tax against LLC members until AFTER 09/98 (I think that's the date). That date came and went and Congress issued no new guidance.
So that leaves us with three possible ways to tax an LLC member: subject all pass through income to SE tax; subject NONE of the pass through income to SE tax; subject SOME of the pass through income to SE tax by calling it guaranteed payments to members.
Most accountants I know select Option 3 - they treat some of the money as guaranteed payments to members subject to SE tax. Some accountants take the most conservative approach and subject all income to SE tax just like they were General partners.
Next issue - the revocable trust. First and foremost IANAL and I don't even pay one on this NG!
My understanding is that a revocable trust, like an LLC, is a disregarded entity. It has no identity of its own, no TIN, files no tax return and in fact everything it does is transparent. While the bank account may be titled to the Joe Doe Revocable Trust, Joe Doe trustee, it is in fact Mr. Doe who reports and pays tax on the interest earned and the bank even uses Mr. Doe's SSN for reporting purposes.
Accordingly, under this scenario, I'd say that Mr. Doe's trust, operating a SMLLC would report it on HIS personal income tax return on HIS Schedule C and the entire net profit WOULD be subject to SE tax just as if he were operating it as his own Schedule C and the trust didn't exist.
I believe that the sole member CANNOT be an employee because he essentially owns and operates the SMLLC transparently - UNLESS of course the SMLLC either gets another member or elects to be taxed as a corporation.
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