For quite some time, Ohio CPA Dana Stahl and I have been reviewing and discussing the long running controversy over whether or not income from an LLC is subject to the 15.3% self employment tax on the members’ 1040s.  Dana recently attended an NSA seminar in Baltimore specifically because they had advertised that they would be covering new developments on this issue (“Solution for SE Tax-Finally? This May Not Be What You Want to Hear!”).  I asked Dana to pass along what he learned there, which he did in this email.

Subject: NSA Meeting Update

 

Mr Guru – got back today from that NSA seminar in Baltimore.  The LLC/SE issue was covered on Day 2.  The speaker was a fellow named Bob Jennings (RJ) who apparently has extensive experience as a presenter for such seminars.  Anyway, here’s a brief summary:

 

1.    After a history of the issue, RJ stated that there really is no immediate answer to whether Members are subject to the SE tax on payments classified as distributions.

 

2.    However, he cited a concern with tax shelters.  Should the LLC experience losses after not paying SE tax for profitable years, the potential exists that the IRS could classify the LLC as a tax shelter subject to Form 8271 filing (Registration as a Tax Shelter).  How?  By saying that an LLC Member is a Limited Partner and not paying SE tax on the LLC profits, in loss years, then, we would be distributing the loss to Limited Partners in effect.  Therefore, if more the 35% of losses are distributed to Limited Partners, then we have in effect a tax shelter rather than an LLC.  By not filing the Form 8271, we’d be subject to a minimum $25,000 fine.  Something to consider, I guess.

 

3.    Finally, the question was raised that couldn’t IRS simply reclassify distributions taken from a multi-member LLC as guaranteed payments?  If no money is taken out, I assume there’d be no problem, but most of my LLC Member clients make a living from their LLC businesses, so they do withdraw money.  We’ve always classified them as distributions, but now I wonder if that was wise.

 

That’s about the gist of the session.  Any comments?  As alway, I continue to be concerned about how I’ve treated the LLC/SE issue pertaining to my clients.

 

Talk to you soon,

DS, CPA

Dana:

Thanks for the info from the seminar.  I’m not familiar with Mr. Jennings; but some of the info you attributed to him makes him sound like a bit of a worry-wart.

1.  It sounds as if they were a bit misleading in their advertisements for this seminar in claiming that they had an answer to the SE question. Saying that it’s still up in the air doesn’t seem like it’s worth the trip.

2.  A few years of losses doesn’t make something into a tax shelter requiring registration.  Those rules involve completely different kinds of business ventures and intentions than those our clients are using to operate their for-profit businesses.  It sounds like Mr. Jennings is just grasping for obscure things to worry about that have very little application to the real world.

3.  Same thing.  If we did nothing but worry about the millions of things IRS could possibly do, we would all go nuts.  The status of this issue seems to be the same.  Until Congress enacts a law requiring SE tax on LLC income, IRS seems too nervous to require it by their own regulations.  They were slapped down a few years back when they tried to make LP income subject to Medicare tax; so they are very unlikely to stick their necks out trying to do the same thing with LLCs.

Nothing you said makes me worry about needing to change our approach to treating SE tax as optional for LLC members on both their K-1 income, as well as capital distributions. 

Those are my reactions to what you passed along, for what it’s worth.

Kerry

Follow-Up:

I have spoken with Dana on the phone since this email exchange and he assured me that, in spite of not nailing down the LLC-SE tax issue, the seminar was very worthwhile and Bob Jennings was very skilled at presenting the material and had a lot of excellent tips on how professional accountants can avoid lawsuits.

Q:

Subject: Re: S or C Corporation

I am part owner of a C Corporation. I have read your articles and they are quite impressive as to the knowledge one can gleam from them.

I have a few questions that, if you have the time, would be appreciated if you can answer them. Our Corporation is set up as a Nevada Corporation, but doing business ONLY in Wisconsin. Is there any benefit to this at all? We have been in business for a little over a year (this September 2005). Unfortunately due to circumstances beyond our control, we did not file taxes last year with the IRS. What is the penalty for this? We actually evened out with costs and income. We are in the process of finding out if we want to become an S Corporation or remain a C Corporation. Please help….Thank you in advance for your time.

Sincerely,

A:

I’m glad you found my articles informative.  However, they are in no way intended to be a substitute for the services of a competent tax advisor who can better analyze your unique situation and help you come up with the best strategies for your goals.  Trying to run a business, especially a corporation, without a professional tax advisor is reckless and irresponsible and would be grounds for legal action against you by any shareholders who trusted you to exercise proper fiduciary responsibility.

Incorporating in places like Nevada or Delaware and expecting that it relieves you of any tax obligation in your home state is a common and very costly mistake that amateurs make, and a professional can properly advise on.  Regardless of where your corporation has been chartered, if it operates in other states, it will have to file tax returns with those states.  The actual tax owed to each state is usually based on an allocation of such things as sales, payroll, and assets in each state.  In your case, it would be 100% in Wisconsin.

Any penalties you will owe on delinquent taxes will be based on the amount you owe.  Generally, if there are no taxes due, there are no penalties.  However, until you actually file your Federal and State tax returns showing what your actual tax obligations are, IRS and the Wisconsin DOR are apt to assume that you have millions of dollars in unreported income.  So, you need to get your books completed ASAP and have a tax pro prepare your tax return before IRS and DOR come after you.

As I mention on my website, I am a big believer in using a non-December fiscal year for C corps.  If you didn’t start up your corp until September 2004, you might not even be late, depending on what month you choose to end your corporate tax year.  This is one more issue that you should work on with your tax advisor.

Good luck.

Kerry Kerstetter

Follow-Up:

Thank you so much Kerry – this information is much appreciated!

 

 

From a reader:

Subject: For your blog

 

Conrad Teitell, LLM (principal at Cummings & Lockwood) has initiated a website to encourage permanent legislation on charitable IRA  rollovers.  The website is at: IraGift.org

You may consider this for your blog.

James W. Fogal, CFP

James:

Thanks for passing that along.  I wasn’t aware of that bill; but it makes a lot of sense.  I’ve long thought that it was crazy that it’s more beneficial tax-wise to donate pre-tax retirement accounts to charity after you pass away than while you are alive. 

I will include this on my blog.

Kerry Kerstetter

 

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