Discussion:S corp or LLC....I say LLC....what say yee?

He is unlikely to make very much more than what the IRS would consider a reasonable salary for an electrician any time soon. Even if he adds some employees, that will likely not change significantly over the intermediate future.

So let's say that he makes $50,000 and his IRS reasonable salary is $50,000.

Under an LLC, he pays self-employment tax of 15.3%, he would receive a deduction for 1/2 of SE tax on his 1040.

Under an S Corp, he pays FICA of 15.3% on the salary amount. 1/2 of the fica would reduce taxable income on his 1040.

For his efforts, however, his accounting tab goes up because of the extra filings, payroll tax remittances, plus he has to deal with the corporate administration pieces. Any savings that he wold realize down the road would be eaten up by the administrative and accounting costs of the S corp. It would benefit me to steer him towards an S corp, but that isn't what I am about.

If at some point he finds the keys to success and starts making a lot of money, he can convert his LLC to an S corp at that time.

Thoughts?

Thanks, Michael

Thanks, I was looking at the average US salary for an Electrician III which is the services that he would be providing to his company. That is the IRS interpretation as I understand it....

Did I miss something?

Thanks, Michael

And RayR: not saying you are wrong or reopening the whole reasonable comp issue. But I think 15-20K in this situation is, shall we say... "aggressive". (IMHO)

The following is from Vern Hoven tax seminar:

Treasury Report Complains about IRS Audit of S corporation Reasonable Wage (Treasury Inspector General for Tax Administration Audit # 200230027)

A Treasury audit report entitled "The Internal Revenue Service Does Not Always Address Subchapter S corporation Officer Compensation During Examinations" criticizes the IRS' audit effort when addressing insufficient S corporation wages to owner/employees.

The report analyzed 84 S corporation returns that had been audited by the IRS. On the cases, the average wage reported was $5,300, while the average M-2 distribution was $349,323. The Treasury report concludes that S corporations continue to pay low wages to corporate officers and shareholders in order to minimize FICA tax and that the IRS is not addressing the understatement of tax in an aggressive manner.

Comment: Tax preparers must expect action by the IRS in this area ... as soon as the IRS trains their small business auditors!

From what I read, the IRS requires a reasonable salary for the person providing services to the corporation. Since so much of the IRS enforcement time is spent fixing M-2 distribution that were wages, they were considering (at least one article I read said so) closing the exemption of FICA on M-2's.

Given the extra accounting costs, compliance costs (meetings, minutes, etc.), and the risk of audits and the IRS penalizing us for a bad call...I don't see that an electrician who is unlikely to make more than a reasonable salary would even want to elect S corp.

For RayR, I would question how applicable that article you quoted is. The reason I say that is everything I read said that the IRS is becoming militant about this area of S corps. I read a LOT of articles about the IRS reclassifying distributions to salary and fining the owner. Not doubting you or your opinion, just questioning whether the environment shifted since that article you posted was published.

Have a great holiday all!

Michael

I guess my question is whether the IRS interprets a fair salary based on the services provided or if they interpret it considering the fluctuation of business income. I don't know that the IRS even knows the answer to that one as I get the feeling it is a case by case basis.

However, my gut feeling is that they interpret it to be a salary as if paid to an employee which generally doesn't take into account the profitability of the company.

Not arguing, just more or less thinking out loud. I wish the IRS would clarify this!

Michael

However, you would only want to do this if you are certain he will not be picking up any other members. A friend of mine attended a seminar this week and learned that this scenario with multiple members ("shareholders") can lead to a situation where the Sub S is challenged and lost. Then whattayagot?....double taxation.

I met with the wife who has a finance degree and plans to do his bookkeeping for him. Here is what happened:

1) She said that while working as a bookkeeper, she had to call something in to the government and wanted to know what that was.

2) I found out that this guy was operating a part time business after his 40 hour+ a week job working for another electrician.

3) He planned to only bill about $18,000 next year and make a net income of about $8,000.

4) Despite the MOUNTAIN of evidence that an S Corp was a horrible suggestion given their facts, the wife demanded that they were going S corp.

5) The wife had the gaul to tell me--during the intial FREE consultation--that all she wanted from me was for me to tell her what to file and when.

6) He wanted to know if he could buy his wife a car and expense it to avoid taxes--no business use, of COURSE.

7) He wanted to challenge me on how often the IRS actually reclassifies S corp distributions to income and charges the penalties (while holding an article I printed for them showing them the facts of the IRS stepping up enforcement).

I thanked them for their time after telling them "well, you have a lot to think about regarding the coporation options, call me if you need help".

I pity them in about 2 years when the IRS comes calling....she's going to have him in TROUBLE!

I have seem some indications while researching certain tax issues that doctors and lawyers seem to flock to the same types of investments and tend to take the same kinds of deductions. Meaning that they all try to do the same tax shelters and organize their businesses the same way. I don't have any clients currently so I am not up to speed on their organization types.

As for the S Corp? Well, who is to say....look at the varied replies on this thread. Not even the seasoned pros can agree on what percentage or amount of salary verses distribution. It seems to me that it opens me up to potential liability should my advice be followed and the IRS reclassify the client. Since I don't have any firm guidance, I don't make recommendations with regards to S corps other than the basic tax treatments and then tell the client to see a lawyer. In my client's case above, I explained why they WOULDN'T want to do an S Corp--which seems to have worked because they haven't re-registered with the County. The a-holes didn't pay me for my time which is still stuck in my crawl! 8-)

It seems like a very risky proposition because you can't control one of the primary variables and that is what the IRS will do--which largely depends on the agent doing the audit. I believe the IRS will revamp the S corp structure in the next few years anyway, simply because of the numnber of agents who are spending their time reclassifying and the taxpayer headache that results when they do reclassify.

But I am a noo-b so what do I know? ;-)

Michael