Hello, I need some clarification… let’s say we have a LLC with 3 partners with equal partnership of 33.33 each. 2 of 3 people work at the LLC and take salary. 1 works at a different company and makes significantly higher salary. I know that LLC income flows through individual K-1s. What stops us from declaring a higher percentage for 2 of the 3 partners since they are in a lower tax bracket? And still taking equal amount of owners’ draws since taxes are on income only and not based on draws. Thank you!
Partnership members cannot take salary.
The three of you are a partnership and need to file Form 1065 to report the income and legitimate business expenses of the entity. The partnership itself doesn’t pay tax; each of you will report your 1/3 of net income or loss on your own personal return. You cannot pay wages or salary to partners. You must also be mindful of your basis when taking distributions. Partnerships are a notoriously difficult form of business. Good luck.
@Vale
Sorry, it’s a multi-member LLC, not a partnership.
Nova said:
@Vale
Sorry, it’s a multi-member LLC, not a partnership.
It is a partnership unless you have elected to be an S-Corp. Being an LLC means nothing and is not a tax entity.
Nova said:
@Vale
Sorry, it’s a multi-member LLC, not a partnership.
A multi-member LLC is a partnership by default. Or you can register it as an S-Corp. How do you expect to report it on your tax return?
Nova said:
@Vale
Sorry, it’s a multi-member LLC, not a partnership.
Multi-member LLCs are defaulted as partnerships for tax purposes unless you’ve made an election otherwise with the IRS for the multi-member LLC to be taxed as a C or S Corporation.
The allocations are required to have “substantial economic effect” under the income tax regulations. Your example would fail.
Vesper said:
The allocations are required to have “substantial economic effect” under the income tax regulations. Your example would fail.
Thank you. I figured that it would fail, otherwise everyone would be doing this. Just wanted to know how/what would fail.
When partnership payments are not equal to partnership equity, they should be considered guaranteed payments. You talk about an LLC as if it matters, but the IRS does not recognize LLCs. An LLC with multiple members is a partnership. I will mention that partnership agreements are very flexible, and while they must include economic substance, they can be negotiated in many ways.
@Blake
If you and I are in a 50/50 partnership and the partnership makes a payment only to you, then it must be a guaranteed payment? The partnership can’t make a distribution only to you?
At some point, the partner taking the lower profit allocation will risk using up all of his basis in the partnership and then would be receiving draws in excess of basis. If this is a partnership, the partners should not be receiving a salary. Hopefully, they are taking guaranteed payments for services, which is the more appropriate way for them to pick up more of the profit on their personal taxes.
What does the membership agreement say about allocation of income?
Where is your CPA to answer these questions?
Val said:
Where is your CPA to answer these questions?
My CPA did payroll for my partnership LLC and issued W2s for 3 partners. Not all CPAs are good.
This is why you need to have a professional file your taxes.
If you are a partnership, you need to get an EIN with the IRS. You also need a partnership agreement. It should state what percent of income goes to each partner. They can all be different.