LLC Question

[Tax Prep by Deb]

I have a client who just came to the office and asked some questions that frankly I haven't a clue about.

He and two other guys are currently involved in a business that was recently set up as a LLC.

The LLC was set up by a single member that we will call "A". My client and another person are currently being paid by the LLC as employees with all employment taxes being withheld. Member "A" has recently informed him that he and another person will be switched to being paid as a sub contractor and a 1099 will be issued at the end of the year. My client (when all the operating agreements ect.... are drawn up) will become member "B" and another man will join and become member "C". Member A will have 60% ownership and B & C will each have 20% ownership.

My client is just a bit concerned about the 1099 aspect. Basically he was informed that he would have to form his own company, and that it would come under the umbrella of the LLC that is already set up. The main purpose supposedly in doing this is to save taxes, (I'm assuming payroll taxes as well).

Does this sound right? If this is the correct way of doing this, besides the self-employment taxes on the 1099 income, what other taxes might my client be responsible for?

Any thoughts would be greatly appreciated. I have absolutely no experience when it comes to any form of corporation so I feel somewhat at a loss on how to direct him.

Thanks in advance,

Deb!

[kcjenkins]

If he forms his own LLC, it may be a single-member LLC and thus a disregarded entity, and he would file a Sch C on the income. No problem there. Of course, his LLC could be a partnership between himself and his wife, if he wishes, which can be useful for estate planning, etc.

I'm ASSUMING, since we were not told, that the A member's LLC is a SMLLC at this time, and will file as a partnership in future. Because if it is a sub-S corp, then it would not be proper to pay shareholders on 1099s, they would require payroll as owners. Or perhaps that is why he wants them to form LLCs? So that the new LLCs could be the shareholders, rather than the individuals, thereby masking the issue of payroll for shareholder-employees.

Whether the current LLC is a partnership or an S Corp, either form is a "pass-through entity" that does not itself pay taxes, so there are no new taxes related to that. But you should warn your client about the "payroll for Sub S corps owners" issue that the IRS is currently making an audit priority.

[imjulier]

Deb-

Sounds like they will elect to be treated as an s-corp? Or as a partnership? I would advise them to have an operating agreement drawn up by an attorney since we don't know what "A's" motive is. Also, it may be that your client doesn't have enough information to enter into this kind of arrangement. The 60%, 20%, 20% ownership definitely raises some red flags but it depends on how much money will be earned in the business and will your client be paid less as a contractor than they are as an employee. Also, liability issues could arise from contractor treatment. There are a lot of issues in what you are describing and the best advice to give your client is to have a formal agreement and thorough understanding of what their income will be under this arrangement before deciding if it is something they want to do. My 2 cents.

Julie