Discussion:Guaranteed Payment in an LLC if owner is an S Corp
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Discussion Forum Index --> Tax Questions --> Guaranteed Payment in an LLC if owner is an S Corp
| 28 October 2007 | |
| I have a question on paying guaranteed payments in an LLC if S Corporations own the LLC. Here's a little background: Two one-person S Corps form an LLC as a joint venture (they are both architects) and the S Corps are the members. What is the best way to pay them for the services they provide in the LLC? What we would like to do is not pay guaranteed payments in the LLC, but take the profit they make in the LLC into consideration when we pay their salaries in their S Corps since the profit will flow through to the S Corps anyway. Is there any problem in doing it this way? Is there any advantage to paying a guaranteed payment from the LLC? | |
| 28 October 2007 | |
| I don't see how the LLC could pay a 'salary' to the S corps that own the LLC anyway - the S corps aren't natural persons, but I guess that isn't what you asked.
out of curiousity, though, who will front the money to pay the guaranteed payments if the LLC doesn't generate profit? If it is the S corp members, then why even call it a guaranteed payment? They would have a capital contribution or non-deductible loan to the partnership LLC creating taxable income back to the S corps. Why pay tax on money you already have in your own pocket? | |
| 28 October 2007 | |
| If the architects work for the LLC then they hv to be paid by the LLC. either by salary or outside service.
i always wonder will the IRS challenge the legitimacy of the Scorp set up mainly to avoid SE tax. | |
| 28 October 2007 | |
| There must be a book out there these architects are reading. I've had very similar set-ups presented to me. I would guess this is a new firm? In my experience, from a management, long term perspective, this does not work well. Exactly what purpose can they articulate to you for the use of the S. Corps? This is where the discussion starts, because, at the very least, they will have to have particular attention paid to the drafting of their operating agreement for the LLC. You have other tax (and potential licensing) issues, are they an architect qua LLC? or qua S. Corp (remember, and S. is not a disregarded entity)? And this is one case where the accountant has to be fully on board with the attorney (or whatever advisor) suggested this scheme. You will find that architects can never get their hands around the true idea of being in "partnership" with another, they always see themselves as billing their own firm: I guarantee you will find out what I mean by this before it's over, and the OA is critical. And by the way, the word "salary" should be ordered stricken from every textbook on partnership accounting. I've said as much to a professor of accounting in this field, and he agreed with me, but I notice he continued to use the word in his textbook! It is very commonly (mis)used, and I can see that Kevin recognizes this problem as he put the word in italics. Whether it is similar to a salary all depends upon it's context in the case of the particular LLC. | |
| 29 October 2007 | |
| Kevin- in your opinion, assuming the LLC generates a profit, would it be better to pay the architects guaranteed payments from the LLC or take the profit from the LLC into consideration when paying themselves salaries from their S Corps? | |
| 29 October 2007 | |
| well, Cow and Crow point out that the person doing the work should be the one getting paid. If the LLC has a contract with the S corp to provide the service, then the S corp would receive ordinary income, not a share of the profit. In other words, it would be treated as an arms-length transaction NOT as a partner/member. | |
| 29 October 2007 | |
| The parties have to have a meeting of the minds, the OA. Some tinkering can be done by the CPA or whatever to do the 1065, but this goes beyond that. You could make an analogy of independence in accounting, and I think you're over the line in having to make these type decisions. The root of the problem here is that this attempted use is the "LP" and/or "joint venture" side of using an LLC [to do one deal, or say, buy and rent out several buildings] and it would not be uncommon to see two S.'s involved. But in this case, they are running a professional partnership. What is the LLC? An architecture firm? A billing conduit? I think you are going to find that your clients do not have a meeting of the minds here, and that will just be the start of your problems. | |
| 29 October 2007 | |
| This arrangement is starting to sound more like a land mine than a joint venture! The downside to Kevin’s suggestion of having the S Corp bill the LLC for their services is that the income would be subject to Washington State B&O tax twice, once at the LLC level & again at the S Corp level. Kevin’s other comment regarding paying guaranteed payments from an LLC when the members are S Corps (and not individuals) has me wondering if guaranteed payments would be appropriate? I read an earlier thread titled “Can an S Corp own an LLC” started by Tax King and there was an interesting comment by Glmpllc regarding a similar situation:
“ Transactions between LLC and S Corp are eliminated...they didnt happen. LLC activity is reported on 1120S along with S corp activity. If you've taken a "reasonable" salary, then the S corp net income (which includes LLC income) should not be subject to SE taxes. “ Can anyone elaborate on his/her statement? Can I put an APB out for glmpllc? | |
TheTinCook (talk|edits) said: | 29 October 2007 |
| That is true only to the extent that if the S-Corp (one single SCorp) is the sole owner of the LLC, then the LLC is a disregarded entity unless the box gets checked. Note, this only applies to the federal level. You will most likly still have to pay state entity taxes. Also states do not always follow the federal entity classification. | |
| 29 October 2007 | |
| Teri, you must take the comments in context:
Taxking said: "Hey, Taxking here. This is a very interesting topic. In 2006 I formed a Nevada S-corp and a Georgia LLC. The S-corp is the sole member of the LLC..." GLMPLLC responded: "TaxKing, No sched C on 1120S. Transactions between LLC and S Corp are eliminated...they didnt happen. LLC activity is reported on 1120S along with S corp activity. If you've taken a 'reasonable' salary, then the S corp net income (which includes LLC income) should not be subject to SE taxes." GLMPLLC is responding to a question about an SMLLC 100% owned by an S corp. That is not your situation. You have a MMLLC 50% owned by two different S corps. These are completely different beasts. In the case of the SMLLC, the LLC is a disregarded entity which is folded into the S corp. Much like me not counting as income the change taken from my left pocket and added to my right pocket. A MMLLC is treated as a partnership. As such you use partnership accounting principles in accounting for the LLC. Transactions between the LLC and the S corp members are NOT eliminated as they would be for a SMLLC. | |
| 29 October 2007 | |
| Thanks Tin & Jdugan. I did miss the point about the sole owner. Dang! So now I'm back to my original question of which I know there is no black & white answer: Should the LLC pay the architects guaranteed payments or do nothing in the LLC and take the LLC profit into consideration when paying their salaries in their S Corps? Surely, someone else must be cursed with clients that have this set up? | |
| 29 October 2007 | |
| Teri, the beauty and curse of the LLC/partnership is that you can pretty much do whatever the partners/members agree to do as long as it has economic substance. This makes it very flexible but also, at times, complex. The question to ask your architect clients is how do they expect to split profits? If profits are intended to be split 50/50 with each S corp member expected to contribute evenly, no GP are necessary. As cash is available within the LLC, the cash can be distributed out evenly to the S corp members as distributions to members. From that, the S corps can individually pay their owners a "reasonable salary". (Has this topic ever been discussed on this forum??? :) But, maybe the principals intend that the allocation of profits be somewhat more sophisticated/nuanced/complicated/argued-over. In which case, setting up a guaranteed payment to the S corp might assist in compensating each S corp member separately for the value of the services contributed to the LLC by that S corp. The trick here is to develop an understanding and a formula for allocating the profits in a manner that is acceptable to both principals. Greed has killed a lot of partnerships over the years (and that is true regardless of whether the "partnership" exists in the form of a partnership, or some type of corporation.) | |
| 29 October 2007 | |
| Jdugan-
Profits/losses would be split 70/30. You mention that if profits are to be split 50/50, then no GP is necessary and the profits flow to the S Corp. Would it make a difference if the LLC split is not 50/50? | |
| 29 October 2007 | |
| Teri, this is not directed specifically to you, but there are books sitting in law libraries and business school libraries full of partnership agreements based on point systems, you name it, that could possibly be adapted to this situation. The S. Corps. are LLC members, they can receive GP's like any partner, allocations of profits and losses, what have you. There's also the potential professional licensing issue here. But if the CPA's and other practitioners, including the attorneys who do returns, start writing operating agreements on the go, instead of looking at the OA the clients have (or helping them get a proper one if they don't have one), then be willing to step up and accept the liability. As Jdu mentions, what do the principals intend? From experience with this type of situation, I can tell you that they intend to "bill" their own company (the LLC) for their time; & they need to be on some kind of allocation based upon points. I can further tell you that this "partnership" (under some of the ideas mentioned here, and with the S. layer) will not last as a professional practice. And note, they intend to essentially bill this LLC even with the S's as direct members. However, I am not going to assume anything, it's not my problem, it's the client's problem. Now, if the CPA wants to advise on it, take a look at some partnership accounting and agreement books, and work with an attorney and clients to get a proper OA drafted. | |
| 30 October 2007 | |
| This may not be right on point as I didn't have time to read the details of your thread, but just finished researching a similiar matter and found this court case helpful: Grigoraci v. Commissioner, T.C. Memo 2002-202. | |
| 30 October 2007 | |
| Ardecker: thanks for posting the case. I think there is another Grigoraci case also, a full opinion in 2004, I have not read that one. | |
| 30 October 2007 | |
| Thanks Ardecker. The Grigoraci case is similar. What other conclusions did you draw from your research? | |
