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Posted by Haskel LaPort on April 24, 2008, 7:05 pm
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> On Wed, 23 Apr 2008 17:14:23 EDT, "Haskel LaPort"
>
>>
>>> On Tue, 22 Apr 2008 21:44:30 EDT, "Haskel LaPort"
>>>
>>>>I was requested by a taxpayer to look at a 1065 prepared by his
>>>>accountant.
>>>>The taxpayer purchased a business in 2007 using funds provided by a
>>>>mortgage
>>>>on his personal residence. Because the property is half owned by his
>>>>wife,
>>>>she insisted on having a ½ interest in the new business. The attorney
>>>>formed
>>>>an LLC naming both the husband and wife as equal partners and that both
>>>>assets and income were to be divided 50/50. The wife is not involved
>>>>with
>>>>the running of the business.
>>>>
>>>>The accountant divided the 2007 $60,000 profit evenly on the 1065 but
>>>>reported only the husband's half as self-employment income and the
>>>>wife's
>>>>as passive income and not self-employment income. Is there any
>>>>justification
>>>>for how the accountant handled this situation?
>>>
>>> I think you have two issues:
>>> 1) Is the LLC really a partnership for tax purposes?
>>>
>>> See IRC 704(e)
>>>
>>> 2) If answer to #1 is yes, then is wife's share subject to
>>> SE tax?
>>>
>>> The argument is that the wife's interest is "like" a limited
>>> partnership interest so she doesn't owe SE tax under
>>> 1402(a)(13). But legally for state law purposes she isn't a
>>> limited partner. She is an LLC member. So how will a court
>>> rule? We don't know. How will IRS rule? Again we don't
>>> know. The best we may be able to do is look at Proposed
>>> Regulation 1.1402(a)-2. However this proposed regulation
>>> (issued 1/13/97) will not be effective until finalized and
>>> after Congress told IRS to postpone finalizing them for a
>>> while nothing has happened.
>>
>>While the regulation is not finalized one would be hard pressed to deny
>>that
>>the proposed regulation represents treasuary position on this matter.
>
> I would agree that it is unlikely that the IRS will disagree
> with the proposed regulations but we don't know for sure.
> Obviously Congress disagreed or they wouldn't have told IRS
> to put them on hold for a time certain (I don't recall how
> long the hold was but it expired a long time ago).
>
>>I read all the paper work the attorney prepared for the formation of the
>>LLC
>>and there is no distinction made between the husband and wife. Both can
>>contract for the LLC and are equal in all respects.
>
> Did you resolve issue 1? What was your conclusion?
Both the taxpayer's accountant and myself agree that this is a parnership. I
am of the belief that the wife should not have been made a member of the LLC
in the first place. The attorney could have found other means of protecting
the wife's interests beside making her a member of the LLC. (Mortgage on
home used to finance purchase of business).
When I first found out that a two member LLC was formed my concern was that
when the annual profit climbs to 200,000 (Which it will) both the husband
and wife would have to pay the maximum amount of self-employment taxes on
the profit. This future event would certainly shed light on why forming a
two member LLC was a bad idea.
>
> If you decided the LLC was a partnership for tax purposes
> then based on your additional information that she is able
> to contract on behalf of the LLC she would be subject to SE
> tax under the proposed regulation.
>
> Some argue since the proposed regulation is not effective
> until finalized and Congress expressed its displeasure about
> the proposed regulation then the definition of a limited
> partner for SE purposes is open to interpretation. They
> then conclude that a reasonable interpretation is that an
> LLC member is enough like a limited partner that they
> qualify for the SE exclusion. There are large law firms all
> over the US paying their LLP/LLC members guaranteed payments
> for a portion of their income and then making the balance
> not subject to SE tax. I would be shocked if some large
> accounting, engineering, architectural, etc. firms aren't
> doing the same thing.
>
> --
> Drew Edmundson, CPA
> Cary, NC
--
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