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Tax on Investment to an LLC?

I own a sole member LLC. Life was simple when the only capital contribution to the LLC was from me.

Now an investor wants to join in. This investor is not from the US.

(in case this wasn't obvious, my LLC is US based and I live in the US as well)

I don't want him to join as a member but rather contractually promise some returns in the future (if the LLC makes enough profit of course).

This is almost as if it is a loan but it's not really a loan, it's an investment.

Do I have to pay tax on that investment? (it's less then $15K)

If so, is there a way to label this money such that it would be considered taxable?

Please note: I am not asking to evade taxes. I am only asking to be tax-smart. No one likes to pay more taxes than necessary, especially when every penny from this small investment is critical to the LLC success.

Advice?

Thank you, John

Reply to
jgarbenzell
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Oops... please correct this irritating typo that reversed the meaning completely:

Instead of "is there a way to label this money such that it would be considered taxable?"

it should read:

is there a way to label this money such that it would be considered NON taxable?

Thank you, John

Reply to
jgarbenzell

In the base case an LLC with more than one participant is taxed as a partnership. In the base case, under section

721(a) your partner's contribution would not be a tax event for either you or for them. However partnership taxation is a bit complex and there are some exceptions to the general rule.

It is not immediately clear to me if this sort of funding event rises to the level of having formed a partnership. It could instead, as you say, be a loan with the LLC's future income pledged as security. If it is characterized in that way, then it is certainly not a taxable event for you to receive the load proceeds.

Steve

Reply to
Steve Pope

I think you'll have to make a choice. You can characterize it as a capital investment, in which case it's not taxable income but your investor has become a member of your LLC. So now it is a multi-member LLC, no longer a disregarded entity but taxed as a partnership. You'll have to modify the LLC's operating document, if it has one, or draw up an operating agreement. You'll need an attorney's help for that.

The other alternative is to treat it as a loan, with payment of interest and principal contingent on operating results of the business. Again, you'll need an attorney's help to set this up.

Whatever you do, be sure that all of the terms and conditions of your arrangement with your investor are clearly set out in writing. Otherwise you have a recipe for expensive litigation in the future.

Katie in San Diego

Reply to
Katie

Exactly. But this isn't just a tax issue. It also has other serious legal implication.

First, if the investor isn't also a managing member, his investment implicates the securities laws. If you don't comply with those, there could be some real legal problems if everything doesn't go perfectly.

If the money is taken as a loan, it could easily violate usury laws, which could also get you both into trouble.

Really, spend the money to talk to a lawyer before you do something that can't be fixed.

Stu

Reply to
Stuart A. Bronstein

I'm with Katie on this - you either have an investor or a lender. You get to pick, but pick you must. You may also decide what the repayment terms are and I see no legal reason that can't be whatever you both agree to. BUT you must be careful and remember that tax law is governed by the theory of substance over form. Word your loan agreement incorrectly and the IRS can reclassify it as a capital investment and BANG - you now have a multi member LLC.

You also need to be careful about the Tax Shelter Rules - I do NOT do much work in this arena but I seem to recall special rules if more than a certain percentage of profits (20% or 25% come to mind) of escape U. S. taxation then you have to abide by the restrictive and tricky tax shelter rules.

Good luck, Gene E. Utterback, EA, RFC, ABA

Reply to
Gene E. Utterback, EA, RFC, AB

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