Formation of LLC - Tax Advice

[Yardley CPA]

Received the below email from a client who is forming an LLC in New Jersey.  My experience is mainly in personal income tax prep and I do not normally deal with the formation of LLC's or Corps.  It's my understanding that a corporation does not afford you significantly more protection than a Single Member LLC, ultimately if someone is coming after you, they will come after you personally once all the assets of the corp are exhausted.  With that said, I have no experience or specific knowledge about that.   The new tax law does provide the 15% rate for corps.  This individual is MFJ and their combined income is in the $200K range.  I have advised him of the specific requirements of an in-home office.  I would appreciate your thoughts and suggestions on how to respond to this client:

 

I have started an LLC as of January 3 2018 for consulting work that I have been asked to do.  The income should not exceed 30k per year.  I am reading some articles that say I should give the spouse 6% stock to get better tax rates, (which has to be done within 75 days of formation)  or have the LLC taxed as a corporation so it is taxed at 15%.  I do have an EIN number.  What is your advise?  I have started quickbooks online to track expenses, and I am adding the mortgage, vehicle lease, utilities etc so we can figure out what I can charge for the home office.  I do have a room that is used as an office for the business.  I know this is based on sq foot, so I will figure that out.

[Lynn EA USTCP in Louisiana]

IMO at the income level he is expected to earn via the LLC he should leave well enough alone.  Gifting the spouse 6% stock renders the default partnership, with the need for filing a 1065.  If he elects corporate status the tax rate on net income is 21%, not 15%, with the need for payroll and its accompanying reports, and filing an 1120, complexity which he would more than likely not appreciate.  If he leaves it as a SMLLC then the default filing is a schedule C as part of his 1040 package.  If his other earned income is near the FICA limit then his medicare liability will not be much (under $900).   Just my $0.02, whatever that is worth.

Lynn

[DANRVAN]

First of all, stay away from giving any advice in regards to corporation vs LLC, that is legal advice for lawyers to handle.  LLC'S are a creature of state law and have nothing to do with tax law.

It looks to me like he should file as sole proprietor, Schedule C. The income would then be taxed at 24% vs 22% at the corporate level according the information in your post. Even if he goes with C. corp, he will need to pay a reasonable salary which will come back to him at 24%.  A reasonable salary would probable eat up most of the $30,000 profit anyway.

Also, as a sole proprietor, he should be eligible for the new section 199A deduction.  As I read the code, a sole proprietor is not required to reduce Qualified Business Income by a reasonable salary.  Also, per 199A (d)(3),  he should fall below the threshold amount for service income. 

[DANRVAN]

20 minutes ago, DANRVAN said:

Also, as a sole proprietor, he should be eligible for the new section 199A deduction.  As I read the code, a sole proprietor is not required to reduce Qualified Business Income by a reasonable salary.   

Need to put emphasis on "should be" or change to "might be".  199A (c)(4) specifically refers to " reasonable compensation paid to the taxpayer by any qualified trade or business of the taxpayer for services rendered with respect to the trade or business" and guaranteed payments. However,  it is possible reg's or technical correction could extend that to include draws by sole proprietor in amount considered reasonable compensation.

[Terry D EA]

I agree with both posts above. I too feel he should leave well enough alone.

[BulldogTom]

17 hours ago, DANRVAN said:

Need to put emphasis on "should be" or change to "might be".  199A (c)(4) specifically refers to " reasonable compensation paid to the taxpayer by any qualified trade or business of the taxpayer for services rendered with respect to the trade or business" and guaranteed payments. However,  it is possible reg's or technical correction could extend that to include draws by sole proprietor in amount considered reasonable compensation.

I did not think about that for my Sole Proprietors.   So if it is a side hustle, legitimate, but not the full time occupation of the owner, and they don't take a draw but leave the profits in the company, you think the owner will have to determine what is reasonable compensation and deduct that amount from the income of the SCH C to arrive at QBI for the deduction?

Tom
Modesto, CA

[DANRVAN]

On ‎01‎/‎17‎/‎2018 at 6:44 AM, BulldogTom said:

I did not think about that for my Sole Proprietors.   So if it is a side hustle, legitimate, but not the full time occupation of the owner, and they don't take a draw but leave the profits in the company, you think the owner will have to determine what is reasonable compensation and deduct that amount from the income of the SCH C to arrive at QBI for the deduction?

Tom
Modesto, CA

I don't see how reasonable compensation could be attributed to an amount which never drawn out by the sole proprietor. Also, in regards to a partnership in which a partner never took out any guaranteed payments or draws,   I don't see where 199A (c)(4) would come into play at this point.

[DANRVAN]

On ‎01‎/‎17‎/‎2018 at 6:44 AM, BulldogTom said:

I did not think about that for my Sole Proprietors.   So if it is a side hustle, legitimate, but not the full time occupation of the owner, and they don't take a draw but leave the profits in the company, you think the owner will have to determine what is reasonable compensation and deduct that amount from the income of the SCH C to arrive at QBI for the deduction?

Tom
Modesto, CA

The code uses the terms "paid to" and "payment...to".  Therefore if there were no payments made, then I don't see any reasonable compensation paid in respect to 199A.