Any tax/accounting experts out there?

[koonja]

For my state, if you begin a LLC you are given 3 options in choosing how you will be taxed.

1) Be taxed as a corporation
2) Be taxed as a partnership
3) Be taxed as an S-corporation

From what little I know, I know that S-corp and partnership are the best options, because under those options, the taxes 'pass through' the company and are instead imposed on the individual member's personal income tax (so you avoid double taxation). So if they're the same in this sense, what differentiates the s-corp from the partnership taxation?

I've read that a partnership will be subject to about a 15% self-employment tax, whereas a S-corp will not be; the catch being that the s-corp will usually require more paperwork and formalities. Is this accurate?

If anyone can clear this up for me, a PM would be appreciated!

 

[johnnykillz]

TT if I recall correctly, may be the man to speak with concerning this matter.

I think he's a CPA.

 

[BobD]

It's that special time of year.

 

[beryirish]

give me two more years and I'll answer your question

 

[ClausentoTate]

http://www.cpa-resource.com/industry-terms/Self_Employment_Tax/

This sums it up pretty well.

PS - In most instances, you want S Corp status. LLCs are just the states' way to drive in business, but letting some partners invest without worrying about losses. You should consult a CPA that's less drunk at the moment

 

[NankerPhelge]

I'm not an accountant, but I think you've got a pretty good handle on this. That 15% self-employment tax in the partnership scenario is a killer, because you get taxed the 15% on any income that is retained in the business, and also on any draws you take, in addition to personal income tax on those draws. Which is the reason I converted my firm from a partnership to a professional corporation at the beginning of this year. The extra "paperwork" is well worth it in my mind. However, this is not accounting or tax advice, as I am not qualified to give it. Only my personal experience.

 

[Irish Houstonian]

I deal with these entities a lot, and one thing I can say with absolute assurance is that only a C-Corp gets taxed at the entity level. All the rest you mentioned all pass-through -- meaning that each owner is taxed individually as ordinary income on the "gains" of the entity. (Which also means that, for example, even if your partnership doesn't issue a distribution of all its cash, you'lll still be taxed on the total gains of the partnership on your form K-1.) The IRS calls it "constructive receipt".

I am a bit ignorant, however, as to employment tax in S-Corps versus C-Corps or other entities. In my limited opinion, 99% of the time the most favorable tax route is not to be an "employee" at all but rather a 1099 independent contractor. If you can do that you avoid the FICA/SS/etc. headache for your company, but you have to genuinely be an independent business entity performing services for the company.

 

[MJ12666]

I am a CPA and would need to provide a little more information for a truly accurate explanation. With that said here are some generaly rules:

1. Irish Houstonian is correct about the C-corp. Basically the corporation files its own tax return and is taxed on any income the corporation earns. If you receive a salary from being employed by the corporation, the corporation will be responsible for half of your social security tax and you will be responsible for the other half (which should be withheld from your paycheck). If you received distributions from the corp. in the form of dividends, this is simply dividend income.

2. Partnerships do not pay tax even though they may be responsible for filing a partnership tax return. This return is simply for informational purposes and the individual partners will receive a tax form called a K-1. The K-1 should reflect the year's income or loss from the partnership attributable to each specific partner largely based on the partnership agreement. Each partner will need to pick up his (or her) share of the partnership income on their individual tax return (losses may be deductible depending on certain factors). There is no 15% tax on partnership income. If you are a salaried employee of the partnership, the application of the social security tax is the same as describe above under the C-corp. Where it gets a little complicated is that is wne actual cash distributions from the partnership are made to the partners. These distributions may be considered compensation and therefore subject to self-employment tax (I think that is what you are referring to the 15% tax in your original post).

3. Being taxed as an "S" corp is exactly the same as described in point 2 (partnership) above. No difference.

Basically what the forming of an "S" corp or a partnership really comes down to is liability. Under an "S" corp the corporation has liability for its products and the actions of its employees and /or partners, while under a partnership, the general partner is personally responsible. Hope the above is helpful.

 

[koonja]

I am a CPA and would need to provide a little more information for a truly accurate explanation. With that said here are some generaly rules:

1. Irish Houstonian is correct about the C-corp. Basically the corporation files its own tax return and is taxed on any income the corporation earns. If you receive a salary from being employed by the corporation, the corporation will be responsible for half of your social security tax and you will be responsible for the other half (which should be withheld from your paycheck). If you received distributions from the corp. in the form of dividends, this is simply dividend income.

2. Partnerships do not pay tax even though they may be responsible for filing a partnership tax return. This return is simply for informational purposes and the individual partners will receive a tax form called a K-1. The K-1 should reflect the year's income or loss from the partnership attributable to each specific partner largely based on the partnership agreement. Each partner will need to pick up his (or her) share of the partnership income on their individual tax return (losses may be deductible depending on certain factors). There is no 15% tax on partnership income. If you are a salaried employee of the partnership, the application of the social security tax is the same as describe above under the C-corp. Where it gets a little complicated is that is wne actual cash distributions from the partnership are made to the partners. These distributions may be considered compensation and therefore subject to self-employment tax (I think that is what you are referring to the 15% tax in your original post).

3. Being taxed as an "S" corp is exactly the same as described in point 2 (partnership) above. No difference.

Basically what the forming of an "S" corp or a partnership really comes down to is liability. Under an "S" corp the corporation has liability for its products and the actions of its employees and /or partners, while under a partnership, the general partner is personally responsible. Hope the above is helpful.

First off, I'd like to thank everyone above for giving me advice. I really appreciate it!

The LLC we're starting is a very small one. It's just me and my friend/partner, and it's a website and we will not have any employees right away. In our operation agreement, him and I will receive the profits monthly. MJ12666, the part that I have bolded is what I have a question about...

Since we'll be receiving our 'share' monthly, we'll be taxed that ~15% if we choose to be taxed as a partnership. Do I understand that correctly? If so, would choosing to be taxed as an s-corporation avoid that 15% taxing on our monthly income, and therefore be a better option? And if I'm correct in guessing that choosing to be taxed as an s-corporation will avoid the ~15% tax for us, what is the catch?

Again, thank you guys for trying to help me out.

 

[NankerPhelge]

MJ12666:

I admit that I am an idiot when it comes to accounting, but there is one thing in your post I didn't understand. Maybe my CPA steered me wrong, or I misunderstood him, or I misunderstand your post.

Let's say I have a 50/50 partnership that generates net revenues of $300,000 last year. I take $100,000 in draws and so does my partner, leaving $100,000 in the company. My understanding is that I will pay 15% unemployment tax on both the $100,000 I take out and on my share that I leave in the company ($50,000). In addition, I will also pay personal income tax on the entire $150,000, that which I took and that which remains. Is that right?

Now, if I incorporate as a PC, and choose the sub-S election, my understanding in that in the same scenario, I will pay income tax at whatever my rate is on the $100,000 I take, but not on the $50,000 I leave (until I actually take it as income, let's say next year). Or, even if I get taxed on all of it (the $100,000 I took as income and my half of the $100,000 that I leave in the company), I don't pay the 15% self-employment tax on any of it, since I am not really self-employed, but work for a seperate legal entity, i.e., the PC.

Am I anywhere near close?

 

[irishpat183]

I owed and operated my own company for about 4 years....Go with the S-corp. That way, liablities pass through the corp and they can't come after your personal stuff should something go down. (taxing is the same, I believe)

That's as simple as I can put it.

 

[MJ12666]

NankerPhelge,

You are correct regarding the taxation of partnership profits. If your share of the partnership business income is $150,000, you will need to pick up the entire $150,000 in your personal return and pay self-employment tax on $106,500 (I believe that is the limit for 2011). Also keep in mind that the nature of the income stay the same. For example if $75,000 pertains to business income and $75,000 pertains to interest, then only the $75,000 would be subject to self-employment tax and the other $75,000 would need to included on your 1040, schedule B (and would not be subject to the self-employment tax.

You are partially correct regarding the taxation of S corp. profits. The profit flow though to the owners in the year the income is earned (regardless of distribution). You reduce the self-employment tax on C corp. earnings as you can designate the amount of income as it pertains to salary earned. However, keep in mind that the amount must be reasonable and the IRS has the final say on what is reasonable and what is not.

 

[NankerPhelge]

MJ1266:

Thanks. I guess I wasn't as far off as I thought. The info is greatly appreciated. Send me a bill! I have plenty of V-Bucks.

 

[koonja]

NankerPhelge,

You are correct regarding the taxation of partnership profits. If your share of the partnership business income is $150,000, you will need to pick up the entire $150,000 in your personal return and pay self-employment tax on $106,500 (I believe that is the limit for 2011). Also keep in mind that the nature of the income stay the same. For example if $75,000 pertains to business income and $75,000 pertains to interest, then only the $75,000 would be subject to self-employment tax and the other $75,000 would need to included on your 1040, schedule B (and would not be subject to the self-employment tax.

You are partially correct regarding the taxation of S corp. profits. The profit flow though to the owners in the year the income is earned (regardless of distribution). You reduce the self-employment tax on C corp. earnings as you can designate the amount of income as it pertains to salary earned. However, keep in mind that the amount must be reasonable and the IRS has the final say on what is reasonable and what is not.

Using your example, if you file to be taxed as an s-corp rather than a partnership, will you avoid the self-employment tax on the $106,000? In my state I have the option of having an LLC taxed as a partnership or s-corp and I'm struggling to find the difference (besides the difference in paperwork).

 

[RDU Irish]

SI got slammed this year since I didn't realize my NOL carryforward is applied AFTER self employment taxes on pass through profits.

Give me a consumption tax and my productivity would go way up since I wouldn't spend so much time wondering how our tax code was going to screw me next.

 

[RDU Irish]

kuehnja - are you saying that you are OK recognizing zero profits as income (subject to payroll tax)? Seems like an audit waiting to happen to me.

 

[koonja]

kuehnja - are you saying that you are OK recognizing zero profits as income (subject to payroll tax)? Seems like an audit waiting to happen to me.

That's the thing. I don't really know what I'm saying, lol. I want to recognize profits, I don't want to get into any 'funny' business. But I have the option to choose how I want the LLC to be taxed, and with what I've read, the partnership AND s-corp option both only tax the personal incomes of the members, which is good. I also understand that the partnership route will impose ~15% self-employment tax, and I don't know if this means I should choose s-corp instead? I can't find anything that says s-corp will also be taxed that ~15% self employment tax. I know very little about this, obviously, lol.

Will the s-corp also be taxed this ~15% self-employment tax? If so, I just don't see the difference. I just want to choose the best option for us, and I'm paranoid like a 90 year old man who just had someone steal his lunch, lol.

 

[RDU Irish]

I keep having this argument with my accountant b/c I want take the S corp election and recognize some as profits but the question of what is a "fair and reasonable wage" for me is tough. It starts to become a moot point if you make well over the $106K since SS tax goes away. I have had some people tell me that more than 50% to profits vs. wages starts to throw up bigger red flags. It is really an issue of audit risk as much as what is reasonable. Some are more comfortable asking for forgiveness instead of permission.

I know, boo-f-ing-hoo.

 

[RDU Irish]

I also know people that are more like 80% profit to 20% income (100% owned self employed, no employees) and have not been audited on it so I really am curious what others have seen on this.

Then again my accountant talks about a guy that recognized virtually all of his income as profit (no self employment tax) and got rung up by the IRS pretty good, when they did audit him they apparently could look by 5 or more years to really ring him up (more than normal because his stance was "excessive").

Seems there should be a happy medium in there. AND if it is a side business and you receive a W2 from full time employment, you would have a lot more leeway in avoiding self employment tax.

 

[koonja]

I keep having this argument with my accountant b/c I want take the S corp election and recognize some as profits but the question of what is a "fair and reasonable wage" for me is tough. It starts to become a moot point if you make well over the $106K since SS tax goes away. I have had some people tell me that more than 50% to profits vs. wages starts to throw up bigger red flags. It is really an issue of audit risk as much as what is reasonable. Some are more comfortable asking for forgiveness instead of permission.

I know, boo-f-ing-hoo.

So even though the company is an LLC, if you choose s-corporation taxing option, you're electing to 'give yourself a salary', rather than just take the monthly profits, no matter their fluctuation? I was assuming that if you're an LLC and you choose to be taxed as an s-corp, you do not HAVE to give yourself salaries. We only have 2 members and we don't plan on making money, much less charging for our website right away, so maybe partnership is the best option?

 

[RDU Irish]

I am full time self employed through my business. No other W2 income for me. Makes it a slippery slope. If it is a side business, I think you have much more leeway.

NOT AN ACCOUNTANT, just a businessman trying to navigate our byzantine tax code.

 

[Ndaccountant]

Let me preface this by saying that I am not a tax accountant. I got my CPA years ago, but I am an industry guy that deals more with business management that taxes and journal entries. So, please consult a practicing CPA before declaring.

Now, from what I can remember, there are a few things you need to consider, which depends heavily on your business.

Generally speaking, if your business produces any losses, I would go with the partnership since it is easier to deduct on your personal filing.

S-corps are better if you produce income which would generate high self-employment takes. Consult a practicing CPA though, since not every business can be a S-corp. However, if your business genereates passive income, S-corps and C-corps actually make the tax situation more complicated.

Finally, if your business generates income in more than one state, a C-corp might be the simplist way to go to avoid complicated state filings.

So, as the typical accountant normally advises, it depends.

 

[MJ12666]

kuehnja:

You misinterpreted my response concerning the $106,500. This amount is the maximum that is subject to self-employment tax in 2011. Basically the owner of the S corp can make a determination what a reasonable salary is for the work performed for the S corp. If you can justify that the work done would be $50,000 then only $50,000 of your share of the profits would be subject to self-employment tax. However your entire share of the company's profits ($150,000) would need to included as income on your 1040. Under a partnership, $106,500 would be subject to self-employment tax and the entire $150,000 would still need to be reported as income on form 1040.

The obvious tax saving between the two is that you would pay less self-employment tax under the S corp provisions ($50,000 x 15%) versus filing as a partnership ($106,500 x 15%). Your personal income tax liability would be the same under both.

This if only pertaining to federal taxes. All states seem to be different on how they handle these entities.

 

[koonja]

kuehnja:

You misinterpreted my response concerning the $106,500. This amount is the maximum that is subject to self-employment tax in 2011. Basically the owner of the S corp can make a determination what a reasonable salary is for the work performed for the S corp. If you can justify that the work done would be $50,000 then only $50,000 of your share of the profits would be subject to self-employment tax. However your entire share of the company's profits ($150,000) would need to included as income on your 1040. Under a partnership, $106,500 would be subject to self-employment tax and the entire $150,000 would still need to be reported as income on form 1040.

The obvious tax saving between the two is that you would pay less self-employment tax under the S corp provisions ($50,000 x 15%) versus filing as a partnership ($106,500 x 15%). Your personal income tax liability would be the same under both.

This if only pertaining to federal taxes. All states seem to be different on how they handle these entities.

So let's say me and my partner each take in $5,000 per month, totaling $60,000 per year, it won't make any difference whether we choose to be taxed as a partnership or s-corp?

 

[Black Irish]

Not to derail but I'm having difficulty finding a simple answer to this. I recently started a business, sole proprietorship. I have yet to see dollar one in revenue. Do I still have to file a federal quarterly if I've had zero business income?

 

[Ndaccountant]

So let's say me and my partner each take in $5,000 per month, totaling $60,000 per year, it won't make any difference whether we choose to be taxed as a partnership or s-corp?

Is the $5000 salary or profit?

 

[Ndaccountant]

Not to derail but I'm having difficulty finding a simple answer to this. I recently started a business, sole proprietorship. I have yet to see dollar one in revenue. Do I still have to file a federal quarterly if I've had zero business income?

In most circumstances, filing with $0's is safe and can be a good thing if down the line any questions arise with incorrect/challenged returns.

In a single member LLC, you would file a Schedule C 1040. If there is no income, there is nothing to report.

It's up to you, but the safe bet would be to file, especially if you think there will be income later this year.

Again, I am not a tax accountant, but this what I can recall from various continuing ed's and other professional reading.

 

[koonja]

Is the $5000 salary or profit?

Profit. We're not designating a salary to ourselves. Sorry, I should have cleared that up earlier.

 

[RDU Irish]

Garfield needs to wake up and open his eyes all the way. Just sayin'.

 

[Ndaccountant]

Profit. We're not designating a salary to ourselves. Sorry, I should have cleared that up earlier.

If it is profit, then S-corp is better to avoid self employment tax.

However, I don't know all the details obviously, but showing $60K in profit and no salary might raise audit flags depending on the circumstances.