Discussion:LLC Partner on Payroll
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Discussion Forum Index --> Tax Questions --> LLC Partner on Payroll
25 February 2006 | |
| I have a new client who is a 2 member partnership LLC. One client draws from the company and the other is on payroll. Both are 50% for profits/losses. Should a partner be on the payroll? How will this affect them on their taxes? Should the one partner be taken off payroll? | |
| 25 February 2006 | |
| Partners or members of an LLC cannot receive payroll. Their payments must be guaranteed payments. | |
| 25 February 2006 | |
| Azercpa is correct. The partner must be taken off payroll. It is not allowed. | |
FreedomBKG (talk|edits) said: | 25 February 2006 |
| What happens to the payroll and taxes that were already paid for 2005? | |
| 26 February 2006 | |
| That's what I thought, so how do I handle the salary & taxes paid to the partner? | |
| 27 February 2006 | |
| I had a simliar case come up last week. I was advised to treat the payroll as normal expenses and advise the client to discontinue their practice of being on the payroll. While it isn't correct, the net result is materially the same. Except in this case, the non-payroll partner paid 1/4 of the SE tax for the payroll partner. In my case, all the LLC members were on the payroll. | |
| 27 February 2006 | |
| I had that situation a few years ago. I filed amended payroll tax returns with the IRS and state. | |
| 4 March 2006 | |
| Thanks for the all the comments and I've advised the one partner to be taken off the payroll. The partnership is a husband and wife member and their last accountant recommended that the wife be on the payroll in order to receive unemployment for the future. I never would have suggested that do anyone else thinks this is wrong advise. Will they have problems with the IRS if they continue this practice? | |
| 3 July 2006 | |
| Can you tell us exactly how we handle the two specific cases listed above:
1: 25Feb2006 FreedomBKG said: What happens to the payroll and taxes that were already paid for 2005?
I too mistakenly filed both Fed and State payroll taxes for a partner. What forms do I have to complete to retrieve those taxes? | |
Mtmckeecpa (talk|edits) said: | 3 July 2006 |
| 01,
I have used form 941c and form 843 to claim a refund of federal payroll taxes. Not sure, however, if this is exactly what you would need to file. You probably would also need to file a W-2c as well. And similar state returns if necessary. May be a slow few days with the 4th of July celebration.... | |
| 3 July 2006 | |
| I've spoken to IRS agents about this matter. While treating an LLC (treated as a partnership) member as an employee is incorrect, these agents aren't currently pursuing the matter, presumably because there is little practical tax effect of this error.
With my clients that pay wages to LLC partners (unfortunately I have several), I've mentioned this issue, and they see no reason to change the way they are compensated from a way they are comfortable with. They ask what the downside is of this "error", and I can't really tell them anything. Is there any risk/exposure that I'm not aware of? Thanks! | |
| 3 July 2006 | |
| SBF; the downside to this is that the partners who are receiving w-2 wages are in effect receiving an additional share of ss taxes paid for by the partnership and the other partners then are not receiving any ss credits for these wages. The partner who does not receive payroll is funding some of the SS tax for the partner who DOES receive payroll. If the partners are related, then this might not be a big issue for them personally, but it is the incorrect treatment of payments from the ptnrshp. | |
| 3 July 2006 | |
| First time reader, first time contributor. This is a very interesting conversation. Are any of the cases referred to above reporting the earnings to any members as subject to self-employment tax? | |
| 3 July 2006 | |
| I too have a 4 person consulting LLC that pays the members wages. If they all take wages that are the same, and nobody is shouldering any payroll tax burden, is there really any problem with that? | |
| 5 July 2006 | |
| Ther are certain items which have income limitations (Sec 179, Certain Retirement Plan calculations, etc) that may be miscalculated because the partners/members are on the payroll. While I wouldn't spend a lot of time fixing the past, I'd certainly get it straightened out for the future. I've seen this situation before, and you simply need to work closely with your clients to help them through setting up Estimated Tax Payments. Be patient, be persistant...it will make your like easier in the long run! | |
| 5 July 2006 | |
| Thanks, Jim. BTW - what is the rationale for not allowing more than 5% LLC shareholders a salary? From a tax standpoint, they would take a hit from having to pay both sides of the SE tax, instead of having the company pay 1/2 and have that deductible.
I will certainly have a discussion with them in the future. | |
| 5 July 2006 | |
| Hi wow! What "practitioners" know and don't know. apologies for the commentary. bye | |
| 5 July 2006 | |
| Hmmm. Yikes. Definitionally, partners don't get salaries. Why not just give them wheelbarrows of unreported cash? Definitions. So partners are not on payroll. Fundamentally. It doesn't matter that the answer may, in some cases, be near the same. That's irrelevant. If this is a 1065 filer, no payroll for partners. That simple. | |
| 5 July 2006 | |
| JR1 and WesR - I understand that LLC members that operate as a partnership should not receive a salary. I was always just curious about the rationale for this.
If it's by definition, I can understand this. I'd just like to give a better explanation than the one than I have always gave in the past - "because that's the way it is." | |
| 5 July 2006 | |
| I think JimS apparently from Maine, three posts above, probably hits the issues. It's the same as a sole prop. not drawing a salary. It is interesting, because an argument in the past would be the sole prop/partnership isn't a legal entity, so therefore you can't draw a salary from yourself. Since the LLC is a legal entity tho'. . .I guess I'd fall back to suggest that since it's being taxed as a partnership, we follow partnership law, and you can't draw salary from yourself. That'll do until a better answer comes along... | |
| 5 July 2006 | |
| JR1 - solid thinking, and I appreciate your feedback. I kept sticking in my mind that the LLC is indeed a legal entity, unlike a general partnership.
Point taken, I appreciate it. | |
| 5 July 2006 | |
| There are specific income and employment tax guidelines based on the legal entity of a business. The IRS did not create separate tax guidelines for the legal entity of an LLC - it still will treat it as a sole proprietorship, a partnership, or a corporation. If you aren't sure, there are a number of great resources, including a summary on the IRS web site, or through Quickfinder handbooks (they provide great summaries of this tax/legal matters). It also depends in what state the business resides and on ownership. A husband and wife may be treated as a partnership if they share in the profits and losses and jointly own and operate the business (a spouse that owns 100% can have the other spouse as an employee). If they are in a community property state, you can treat it as a partnership or sole proprietorship. By it's nature, a single member LLC is a disregarded entity for tax purposes and it is taxed as a Sch C, with earnings subject to SE tax (unless the election is made to treat it as a corporation for tax purposes). A partnership has its income taxed at the individual level and is generally subject to SE tax. An S-Corp provides SE tax protection (7.65% on both sides) to its owners on distributions (income tax is still paid). All of these have implications on whether or not taking payroll, draws, or distributions are required or not, and in some cases, what is most practical. | |
| 7 July 2006 | |
| Husband and wife are members of husbands medical practice organized as an LLC in a noncommunity property state. The wife spends five hours or less a week with bookkeeping. The LLC pays the husband a wage of $30,000, and reports (accordingly) as if he were an employee. The LLC has a profit after the wage of $140,000. The wife reports $70,000, on their joint tax return as earnings from a partnership as a limited partner and does not pay self-employment tax. The husband perhaps, thanks to the miracle worker consultant, may not be paying self-employment tax on his $70,000, either.
In regards to some of the questions and answers above, yes I believe there are compliance issues. Consider the tax liability issues. The IRS guidance dealing with this topic that I have found important are two sets of proposed regulations, REG-209824-96 and proposed regulations issued in December 1994. Question one, may a taxpayer escape liability by the fact that these rules have not been finalized? Question two, application of the guidance if you choose to follow it. I believe that there needs to be some resolution with this issue. In the context of this issue I believe the bulk of the proposed regulation makes sense and is consistent with prior partnership taxation. However, if the law allows for a tax savings who may care what I think. I would be interested if any of the readers are experiencing any of the issues with self-employment tax that I have described in my case study. | |
| 2 August 2006 | |
| I have a client who recently formed a single member LLC. In order to get the group insurance they wanted, it required them to show 3 employees on the payroll. The owner, his wife, and their adult son. The wife and son are definately employees, but what problems will I have putting him on the payroll as well.
It would be until the end of the year, at which time I'm will file to classify the LLC to be treated as an S-Corporation, and then it won't be a problem. Should I try to get them classified as an S-Corporation immediately? | |
| 3 August 2006 | |
| I have been researching this, and was directed to Steve Kunkel, a CPA and business advisor out here in Los Angeles. (He was cited as a source in an article that I read).
Basically, if you are looking for authoritative guidance, he cited Revenue Ruling 69-184, which states that partnership remuneration is not wages. So again, LLC treatment will follow partnership law (where it elects to be treated as a partnership). From a practical perspective, he mentioned that the act of paying wages in the LLC may cause some issues with the calculations for fringe benefits (like retirement plans). Also, the treatment of Unreimbursed Expenses would be impacted if they fully compensated themselves through W-2, as it would be subject to the 2% AGI limitation on schedule A (instead of being treated as Unreimbursed Partnership Expenses, deducted on Schedule E.). With respect to my one LLC that pays its members wages, i'll let them do it for another year, but counsel them to change for the 2007 calendar year. | |
| 11 February 2007 | |
| In order to pay Members of a 2-member LLC salaries (W2), can the I simply elect on form 8832 to have the LLC taxed as a corporation? And if yes, can the corporation be taxed as an S corporation? Or only a C Corporation? | |
Death&Taxes (talk|edits) said: | 11 February 2007 |
| Yes, Elect S - yes | |
| 25 March 2007 | |
| I'm adding to this discussion instead of creating a new one, because my question is related.
I have a partnership where one partner is putting in considerably more hours than the other. They compensated him first by giving him more retained earnings. I remarked that they weren't really compensating him more, just giving him back more of his basis, and suggested a 1099 for the additional compensation instead. After reading this discussion, I'm wondering if I misspoke. What would be the proper way to compensate the partner fairly for his additional work? | |
| 25 March 2007 | |
| Guaranteed payments are how you compensate you partner over another due to effort. No 1099 required, it is deducted by the partnership and flows through to the partner. | |
| 25 March 2007 | |
| Boy do I feel like an idiot for overlooking that. I do mostly S Corps, and not partnerships, and I completely blew it.
So, since I don't do many 1065's, I'm clearly not doing this correctly. I originally had the $$ as an expense on Schedule F (this is a farm). Guaranteed payments should go on line 10. But when I move the $$ from F to line 10, the net income goes up by $$. GP's are supposed to be deductible to the partnership, so the net income should not have changed, right? Shouldn't the net result be the same as issuing a 1099? | |
| 25 March 2007 | |
| My apologies for my prior post. I was reading the ProSeries summary incorrectly. The ordinary income did stay the same, but the net income changed since it takes into account the Schedule K items.
Thanks so much for your help. | |
| 25 March 2007 | |
| Yeah, 1065's can really be a pain if you don't do them often. I have been working on two all weekend. I'm going to polish off my week with a nice and easy S-corp just to remind myself I can make money in this biz lol | |
Taxestaxes (talk|edits) said: | 29 January 2009 |
| This post I think has answered my questions but I still have one? So 1099 doesnt need to be issued for one partner who is taking a weekly check - its just a guaranteed payment. But what if its not set up as guaranteed payments in original filing of Partnership - meaning when the 2 set up their partnership, they didnt indicate there would be guar. payments for this partner? | |
| 29 January 2009 | |
| Guaranteed payments have a meaning besides just a tax meaning. Some clients will be finding that out one day. I am not sure I understand how it's thrown around here half the time, nor do I understand that they are "required" in any way whatsoever. | |
| 29 January 2009 | |
| A payment to a partner could simply be a distribution of previously taxed but undistributed capital. A "guaranteed payment" is a payment required to be made to the partner irrespective of profit or loss, and which is taken as a deduction prior to the partnership allocating its profit or loss to the partners. If no such payments are required by the partnership agreement to be made, the payment to the partner is a distribution from his capital account (provided he has basis). | |
Taxestaxes (talk|edits) said: | 24 February 2009 |
| So if a partner took money thru the year, and it wasnt a guaranteed payment , and he has no basis, how is that treated? | |
| 25 February 2009 | |
| A distribution to a partner in excess of basis is treated as gain from the sale or exchange of the partner's interest in the partnership (i.e., capital gain). IRC Sec. 731(a). | |
| 9 June 2010 | |
| I have a client who is a partner in an LLC who is 34% the other partner is 66%. They are both on payroll based on these percentages. My client(34%) has been told by the other partner and his accountant that even though the original agreement was to take equal salaries and split profits after expenses that they couldn't do that and the payroll would be at the 34/66 split. My contention was the larger partner is taking more salary that is being calculated as an expense before any profit sharing.
I had advised him that in an LLC they could establish their salaries as they like and take the 34/66 on the profits. Looking for advice as this. | |
Harry Boscoe (talk|edits) said: | 9 June 2010 |
| AFAIK, there's nothing that would require that "partner salaries" be in the same ratio as ownership of the partnership and its income. If I were bold and cynical I would suggest that your client is getting BSed by his partner and this accountant. The "larger partner" is pushing this "littler partner" around. This could be actionable. | |
| 9 June 2010 | |
| Kmix, no salaries to members of an LLC that is taxed as a partnership. See the discussion above. Neither of these parties should be receiving a salary. As Harry suggests, I think Big Guy is trying to take advantage of Little Guy. They can receive guaranteed payments, the amounts unrelated to their ownership percentages but based on the value of the services each performs.
There is an exception in California. Under the California Unemployment Insurance Code, an LLC is defined as an "employing unit" (unlike under the IRC, where an LLC is not defined but must be classified as disregarded, partnership, or corporation). As a result the Employment Development Dept. applies common-law principles to determine whether an LLC member is self-employed or employed by the LLC. Generally a managing member (designated as such in the Articles of Organization) is considered self-employed and is not treated as an employee of the LLC. A non-managing member who performs services for the LLC, presumably under the direction and control of a manager, is an employee and subject to employment taxes including UI, DI, and PIT withholding. See the EDD Information Sheet, Form DE231LLC, [1]. | |
