Discussion:Llc to s-corp
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Discussion Forum Index --> Tax Questions --> Llc to s-corp
| 18 May 2006 | |
| I recently filed an 8832 & 2553 for a LLC client in Connecticut to be treated as an S-Corp for federal tax purposes (late acceptance for 2005). We did this to save taxes on Self-Employment taxes (the partners will each claim about $200k from the LLC in 2005). I just received acceptance from the IRS. The partners are now on the payroll receiving a reasonable salary as owners/employees. I have some questions:
1.) Do shares actually have to be issued to the partners/owners now they are recognized as an S-Corp for tax purposes? 2.) Does the State (CT in this case) automatically accept the IRS's S-Corp election? 3.) Does anything need to be filed with the State (e.g., change the Articles of Organization) if they want to keep the LLC legal status? 4.) For 2005, the partners were not on the payroll. Any recommendations as to how to show salary from the distributions? Please feel free to respond only to parts of the question. Jack | |
| 18 May 2006 | |
| 1. No, the entity is still an LLC under state law.
2. Don't know, most states do, but need to check for CT. 3. No, see 1 above. 4. Put partners on payroll, include their wages in reports: 941s, W-2s. | |
| 18 May 2006 | |
| 1) It is my understanding that for legal purposes they will still be classified as an llc. Therfore no stock issuance.
2&3)Where I am from we don't have state income tax. However it would stand to reason that the states would follow suit with the federal government. I would think for legality reasons you are still an LLC however you are taxed as an S-corp. You may have to file some form to your specific state to register as such. 4) I don't think it is easy as just putting the payroll on a w-2 and 941. They have effectively filed the payroll taxes late and the IRS and state agencies may want to tack on some penalties. You may want to consider what would be better for the client file 1065 for 2005 and then s-corp in 2006 . Penalties on payroll taxes can be fairly large and by the time you figure it all in it may be a wash. | |
| 18 May 2006 | |
| Here's one where I'd roll the dice and book some comp on 1099's, issue the 1099's (might get penalized $50 each, whooppee..), and then toss that comp on Sch. C's for each of them, paying the SE tax. Too late to do real payroll for 05, and I'd document my thinking on this one...that the late acceptance precluded you from doing real payroll, but you didn't want to cheat, so therefore did it this way. That way you will likely still limit your SS cost to the reasonable comp., you start payroll in 2006 demonstrating clearly your intent to do this right, etc. What's the very worst that could happen? You lose all the SS taxes, which you'd lose anyway. Again, whooppee. No risk. | |
| 19 May 2006 | |
| Thanks for the timely responses. A couple of follow-ups regarding the 2005 filing: first JR1, good recommendation on the 1099 -- I'll give that some thought; second Sea-Tax, can I still file a 1065 (then 1120S in 2006) if the effective date on the late filing is 1/1/05? | |
| 19 May 2006 | |
| OK, that's what I thought. Thank you all for your assistance. This is my first time using Tax Almanac and I'm happy with the service (until they start charging us of course!). | |
| 19 May 2006 | |
| Not as it stands you can not file 1065 however you may want to at least look at it first then maybe you can find away to get the election revoked.
As for the 1099 from s-corp to sch c idea , I have used this once or twice in the past and it has worked. However it I have since changed my opinion on this. See w2 income is not the same as se income , on the surface we see it as very alike, however when you start getting into the relm of pension plans and retirement plans it is differnt and from first hand dealings with the IRS on this issue they see it as such. | |
| 19 May 2006 | |
| Another question regarding LLC's election to be taxed as an S Corp. If the member of the LLC is another LLC who actually gets the payroll? Do you have to drill down through the layers of LLC's to see who are the members? Whould that the same for the dividend distributions? | |
| 19 May 2006 | |
| Lois, if an LLC is a shareholder in the S...then no payroll would flow thru to it. Hmmm. Clever. So...a husband and wife own an LLC, which then owns an S...which distributes the profits and no payroll, and the LLC isn't issuing payroll to the partners...kind of the same thing as current LLC issues...how much to take (if any) for SE purposes. If the LLC is an active shareholder, which it would be, and the partners are active members of the LLC, then you still have to book some SE income. But no payroll filings anywhere.. | |
| 19 May 2006 | |
| Then to elect an LLC who's ownership is another LLC defeats the purpose of the self-employment tax savings? Also, wouldn't the IRS argue that the entire amount become subject to SE tax? I am very very confused! | |
| 19 May 2006 | |
| Again, this kicks back to the whole conversation about what you can do with LLC's right now. Repeated, there are no regs in place. IRS has indicated their feelings, but have no basis under Congressional authority for those feelings. So, accountants differ, from taking none under the position that it's a limited partnership interest not subject to SE, to extremely conservative who take it all to SE under the position that an active partner's income is all subject to SE, to everything in between. This wouldn't change anything. A pass-thru entity is passing thru items that do not change in character. So if an S is passing thru actively earned income to an LLC, the LLC now has actively earned income to deal with. Which the lack of LLC regs control.
Make sense? Of course not. Reread carefully three times. | |
| 19 May 2006 | |
| Then they made a poor choice electing this LLC to be taxed as a Sub S because none of the reasons this choice is make come into play. Correct? | |
| 19 May 2006 | |
| My own opinion is that it's always a poor choice to elect S status on an LLC. Too many cloudy issues that I've not heard resolved yet that drive my brain crazy. If you want a corp., create one. That's my opin. But, as to PR issues, while the LLC is unsettled, the S corp isn't. They need to take a resonable salary. That's clear. | |
| 19 May 2006 | |
| Back to my original question and your original answer "But no payroll filings anywhere" - - who does take the reasonable salary? | |
| 19 May 2006 | |
| If the LLC is a shareholder of the S, as you said in your first query...no payroll. You don't issue W2's to an LLC. Merely, probably, need to mark some part of the LLC's earnings as subject to SE tax (since you don't issue W2's from a 1065 to a partner). If this is an LLC being taxed as an S, which your later questions seem to indicate, then the shareholder should be on payroll from the S. | |
| 19 May 2006 | |
| I must be doing a poor job of communicating the situation - let me try once again.
An LLC (who's only member is another LLC) elects to be an S corp therefore will be taxed as an S - who is the shareholder to put on payroll? | |
| 19 May 2006 | |
| Why not have the individual who owns the top level LLC take the wages? IE you have
A - X - Y where A is individual who owns X and X owns Y (as I understand your fact pattern), have individual A get the wages. | |
| 19 May 2006 | |
| But you don't have wages to pay. The LLC-electing S corp has only an LLC shareholder. The S doesn't have an employee. The LLC shareholder isn't an employer as to the owning partner. No payroll. Self employment earnings on the LLC K1 in my opin. | |
| 20 May 2006 | |
| The question is: who was doing the work? There is no requirement that an S corp shareholder must be paid wages. The employee could be a non shareholder. There could be no employees. Who did the work? Was it legitimately contracted out? | |
| 22 May 2006 | |
| The Husband/Wife team who are at the bottom of the LLC's are doing most of the work. They also have two part-time employees. | |
| 22 May 2006 | |
| I vote that husband and wife are required to be paid reasonable compensation. ♫ | |
| 22 May 2006 | |
| I would think attribution rules apply and the statutory authority of the IRS to "look through" entities is clear. | |
| 22 May 2006 | |
| Dennis, are you saying that the S should be paying salaries to those LLC Members? Is that even possible? | |
| 22 May 2006 | |
| They are individuals performing services. They are S Corp officers by attribution. Allocating deemed wages to some sort of Guaranteed Payment seems far more contrived. | |
| 22 May 2006 | |
| How are all the other LLC's electing to be S status taking care of reasonable salary issues. I'm thinking of my own company - I was an LLC for years and elected S status this year. I put myself on payroll for the reasonable salary issue. | |
| 22 May 2006 | |
| A single-member LLC may own S Corporate stock under PLR 9745017 if the single member LLC is taxed as an individual. | |
| 22 May 2006 | |
| If an llc elects to be taxed as an s corp, can the members still maintain unequal capital accounts and receive unequal distributions or do s-corp rules apply? | |
| 22 May 2006 | |
| Also, since the entity is still an LLC, corporate minutes and bylaws ect. do not need to be filed, correct? | |
| 22 May 2006 | |
| Adding to my "Why to not check the box to become an S corp" list.
No bylaws or minutes. So how do you document your salary choices? Note payable to shareholders? Or can there even be such? And should you pay interest? I'm becoming more and more convinced that this is a really bad idea. If you want a corp, make one by birth, not checking a box. | |
| 22 May 2006 | |
| It is my understanding that when you elect S status you file as an S corporation and have to follow all the rules of S status. | |
| 22 May 2006 | |
| Okay, the regs are not yet established on this issue, which leaves a lot of grey area but I am not understanding why JR1 thinks electing for an LLC to be taxed as an s corp is so bad. My interpretation is that by doing this you will eliminate all profits being assessed self employment while still maintaining the flexibility (and a lower level of maintenance compared to an s corp) that an LLC has to offer like making disproportionate allocations and distributions. | |
| 22 May 2006 | |
| The problem, Jen, is just as you suggest, there are no clear rules. Many folks write in to say, well, it's still an LLC, really. If it is, really, then you don't have salary to the owners. And then what about disproportionate distributions? Can you do that? I think not, you elected to be taxed as an S, and that would create a second class of stock, and would that then default it to a C corp? Who knows? These fundamental questions must be answered. To merely elect S status seems perilous at best to me because of all this uncertainty. | |
| 22 May 2006 | |
| I don't think you get to pick and choose the tax treatment, i.e., no SE tax but still have special allocations or disproportionate (if that is what you mean by unequal) distributions. Once you select s-corp, LLC is taxed liked a s-corp and subject to same rules -e.g., disproportionate distributions = more than one class of stock, therby blowing s-election. Be careful. | |
| 23 May 2006 | |
| Here is a great question. Do you have to equilize the prior distributions among members once they elect S status? Knowing that as of 1/1/05 an LLC is now S for tax purposes - what do you do with all the prior distributions? | |
| 24 May 2006 | |
| Here is my situation. We own a 2 member LLC of which the owners take out distribution based on effort put forth into the LLC. The capital accounts are also unequal and we are taxed as a partnership. My goal is to find a structure where we can continue to take out unequal distributions and minimize SE tax. My first thought was to elect s corp status, but after this discussion I am thinking that is not such a good idea. Here is my new plan. Please give any feedback as to what you think. I am going to maintain the LLC taxed as a partnership and form 2 separate S corps for each partner. The LLC will pay/contract the s-corps which will pay the owners. Will this work or are there related party rules that will negate the benefits of forming the s corp? | |
| 24 May 2006 | |
| A distribution based on services is always subject to SE tax. Rather than add additional layers, why not just form a new corp, elect S and then pay wages? | |
| May 24, 2006 | |
| An easy solution if one has s-corp status and needs to pay disproportionate distributions, is to make these unequal amounts as 'bonus' wages and subject them to payroll. This way any distributions to the shareholders will remain in line with their ownership %. This way the shareholder(s) would receive 'reasonable' salary plus bonuses if they happen to contribute more to the company (or for whatever reason.) | |
| 24 May 2006 | |
| Jen: How much are distributions. Oftentimes the issue becomes moot as "reasonable salary" approaches the limits of FICA taxes. E.g., if you are earning 70-80k in the form of reasonable salary or distributions from LLC subject to SE tax creating additional layers to save on the extra income subject tio FICA may not be worth the effort. | |
| 26 May 2006 | |
| What is the consequence if a LLC inadvertantly pays W2 income to a member if that member is a profits interest only member? How should this be cleaned up? How would they change these payments to guarenteed payments even though payroll taxes have already been submitted? | |
| 26 May 2006 | |
| Fortunately, I do not have an issue with unequal distributions for my client. Equalizing 2005 distributions as bonuses may work. They can be deducted by the company in the year accrued (2005) and not shown as income to the recipients until received as long as they are paid out no later than 2.5 months after tax year (2/15/06). But since that time has lapsed, they are now required to be classified as "Deferred Comp". I've seen language that states if you can prove that paying the bonuses out on time was "administratively or economically impracticable" and "unforeseeable" at yearend then you could get a pass. With all that said, you'll have to be creative and I'm not sure how the Accrued Bonuses will affect the 941's already filed in 2005. I wouldn't want to change those and I'm sure a payroll service wouldn't appreciate that either. | |
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