To explain further, if we purchase Target LLC from ‘Our LLC’, can we personally loan Our LLC $500,000, then get repaid over the course of 12 months so that $500k isn’t income? Or is that not how it works? We want to recoup our initial investment into the company as quickly as possible. The business cash flows over $1M per year, and we would love to get our equity down payment paid back to us before taxes (if it is legal). The LLC we are purchasing is in Pennsylvania. We have not formed our LLC yet, so we can form it in Delaware, NY, Florida, or Texas.
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I think the part you’re missing is that taking money out of the company for an LLC isn’t taxable, no matter what the case is (assuming you have basis in the company which you almost always do with an LLC). Tax is based on your profit, not your distributions.
So if you do what you’re saying and you make $1M in year 1, you’ll owe tax on that $1M whether you leave the money in the company or you withdraw all of it to your personal account. Having a loan doesn’t make a difference, it will just be a different way to account for your basis.
@Jesse
Understood. So if Our LLC has $1M in debt to us, and it makes $1M in profits, it is still taxed on those profits BEFORE repaying the loan?
Jessie said:
@Jesse
Understood. So if Our LLC has $1M in debt to us, and it makes $1M in profits, it is still taxed on those profits BEFORE repaying the loan?
Yes correct. Principal of a loan isn’t income when you receive it and so it’s not a deduction when you pay it. You would still be taxed on the $1M in profits whether or not you repay the loan.
@Jesse
Fly in the ointment and I’m not an expert: If this is a loan, doesn’t there have to be an interest component that would be income to the lender?
Kim said:
@Jesse
Fly in the ointment and I’m not an expert: If this is a loan, doesn’t there have to be an interest component that would be income to the lender?
Yes. No point in calling this a loan, just contribute the money to the LLC.
@Jesse
Very helpful. Thank you.
Jessie said:
@Jesse
Understood. So if Our LLC has $1M in debt to us, and it makes $1M in profits, it is still taxed on those profits BEFORE repaying the loan?
To be clear, paying the previous owners (5M purchase price) is also not a deduction, although if you have to pay them interest, the interest might be deductible. And if any part is goodwill, you might be able to depreciate that.
@Jesse
Yes, the only reason I thought it was different with us is because we are giving Our LLC money for the down payment on the company. I was hopeful that the loan to the company would offset the profits. But in retrospect, the IRS isn’t that dumb.
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Is this a simple partnership, or an S-Corp? Based on the facts presented, I will answer more like a partnership. The answer is about the same, just mechanically different.
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Different legal words, but basically yes you can do that. It’s not income, it’s return of capital. The interest is income to you.
It also affects your basis in the business, so not exactly tax free.
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Again, it is tax free, in that your own capital and basis in the investment is typically returned first. The profits won’t be. You will just hit taxable profits sooner.
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Am not a lawyer, but your state of incorporation isn’t going to matter for something this small. So most likely PA will be easiest and cheapest.
Either way, you really need someone who can dig into this with the details and make sure this is done correctly.
@Flynn
I really appreciate the info. I do have a CPA but I don’t know if they’re that well versed in a buyout/acquisition.
These numbers are big enough that you’re going to want to get lawyers involved. I worked in M&A for several years, and I can tell you that having an experienced M&A legal team from an appropriately sized firm is going to save you money in the long run. They will also be able to help you find an accountant who will have experience in this type of financing and who will be able to advise you on the best structure.