Internal Memo
To: PBR (Park, Baines, and Rowe), LLC
Subject: Partnership taxation
Date: 26th July 2020
Facts
This memo is to explain the way forward in treating Baines and Park as employees of PBR LLC and also the subject of self-employment taxes (Koski, 2005, p.33). This memo serves as a guide and reference for assisting PBR LLC and the management with the changeover of the company to LLC. For the last 15 years, PBR has been operating as an S corporation with three partners. The partners agreed on paying Baines and Park $200,000 each as they did before the company transited. Loses and profits are shared equally by all the partners. They decided to take $40,000 cash distribution to each partner, and they think that they will be relieved from the self-employment tax as before the company becomes LLC (v, 2006, p.32).
Issues
Currently, PBR is not an S-corporation; therefore, the issue is to determine how the three partners should be categorized either as employees or self-employed. The treatment of a salary of $200,000 and distributions of $40,000 to maximize the tax benefits of LLC should be determined.
Research and Recommendations
Since PBR has transited from an S corporation to an LLC, both Baines and Park are self-employed members of the company. Concerning Revenue Ruling 69-184, any member that places their energy and time in business are not considered as employees but self-employed. Thus, this year both Baines and Park are subject to self-employment taxes as they are not employees of the company. Additionally, they are taxed in self-employment tax based on their profits or any distribution they get, and they must report in their respective W2. However, Rowe is considered as an inactive member as he does not contribute toward the management. As a result, he is exempted from the self-employment tax.
I would recommend PBR LLR to consider $200,000 as a guarantee payment, and it should be included in the partnership contract. Additionally, in the agreement, they should consist of the significances of these payments. Also, all the distributions as guarantee payments can be used as a deduction for the entire LLC. This deduction will have a direct impact on the net ordinary income from K-1 by reducing it. Thus, the tax bill to every partner will also be reduced.
Conclusion
The fact that PBR LLC has converted its business from S- Corporation to LLC is a commendable milestone that creates the need to be recognized. Also, I appreciate the fact that the company has allowed me to become a tax advisory individual continuously (Keatinge, 2007, p.22). It is evident that changes in the business models also bring changes in taxation, as demonstrated in this case study in the issue of salary and distribution costs. More so, our expert team has proved that compulsory payment of salaries results in a reduction of the self-employed tax amount, which is as per the requirement of Revenue 69-184. Additionally, with the aid of certainty in payment, the ordinary net income will reduce because of the deduction, as mentioned earlier, and due to this change in the business model, the income will form part of their income.
Works Cited
Keatinge, Robert R. “Self-Employment Tax Issues in LLCs Taxed as Partnerships.” Suffolk University Law School Research Paper 07-33 (2007).
Koski, Timothy R. “Self-Employment Tax and Limited Liability Companies: When are LLC Earnings Subject to Self-Employment Tax.” Taxes 83 (2005): 33.
Meade, Janet. “Minimizing Self-Employment Tax of LLC Managing Members.” The CPA Journal 76.6 (2006): 32.