LLC compensation issues

[dmb]

A husband and wife are each 50% owners and the only "employees" of an LLC that sponsors a calendar year DB plan. The CPA sent me copies of the Form 1065 and K-1s to determine the compensation to use for benefits. The main problem (among others) is that there are "Salaries and Wages (other than to partners)" of over $200,000 that turns out was paid to the partners as W-2 compensation. There is nothing listed as "Guaranteed payments to partners". The K-1s show losses of less than $40,000 each. From what i understand, partners of an LLC should not receive W-2 compensation. What compensation should be used to calculate benefits?? Any advice would be appreciated. Thanks.

[Archimage]

You are correct. A member of an LLC should receive guaranteed payments. They are not allowed to receive W-2 income.

[rcline46]

Since I have seen this before and was perplexed as to how an accountant, presumably a CPA could screw this up, it occured to me ask a question...

Is the LLC taxed as a corporation or as a partnership? ( I know - gave you a 1065 not an 1120)

If taxed as a partnership, under what code section are the partners receiving W-2 income from the company they own? Any other authority?

They tend to get real nervous when I ask that in terms of a plan qudit!

[AndyH]

Any questions related to a plan qudit woud make me nervous also! .

[dmb]

The LLC is being taxed as a partnership, i don't know what he's relying on to pay W-2 comp to the members of the LLC

[Guest flogger]

I have no real knowledge on this other than what I was just told by a CPA. He said an LLC can be either a corporation or a partnership. If it's a corp, then the members (owners) would get w-2 income. Otherwise it would be K-1. This is confusing. Any experts out there?

[Archimage]

That is correct. However, you said in your first post that you received a 1065 which means they are being taxed as a partnership. If they are being taxed as a corporation then you would have received a 1120.

[Lori Friedman]

flogger, the accountant is referring to the "check-the-box" entity classification rule. Partnership is the default classification of an LLC with 2 or more members. The LLC can choose, however, to be treated as a corporation by filing Form 8832 with the IRS.

dmb's client seems to have a mishmash of tax treatment. If the LLC filed a Form 8832, it should file a Form 1120 (not a Form 1065). If the LLC didn't make the entity classification, however, it's a partnership for federal tax purposes and generally can't employ its own members.

[dmb]

That is correct and that is the issue, what comp to use for benefit calculations. An LLC taxed as a partnership should be paying W-2 comp to the members of the LLC. A CPA told me i could treat it as Guaranteed payments, someone else says they received a PLR for a similar situation that said they can use the W-2 comp as if it was a corp. I realize i can't rely on someone else's PLR, but just throwing that out there.

[Lori Friedman]

dmb, I'm calling this situation a "mishmash" because the LLC (no check-the-box classification as a corporation) generally can't hire its own members. If a member works for the LLC, his/her "salary" is income characterized as a guaranteed payment for services performed, subject to the self-employment tax. There's no Form W-2. Instead, the member receives a Schedule K-1 with detailed information about his/her share of recognized income.

In your original post, you mentioned a $200,000 expense for salaries paid to the LLC members, with no symmetrical information on Schedule K-1. Do these numbers relate to the 2003 calendar year? (The 2003 Form 1065 has an extended due date of 10/15/04).

[Blinky the 3-eyed Fish]

I think we all agree that the reporting of the "salary" as W-2 for this LLC is incorrect. It would to me compound the mistake if you treated the W-2 reported payments as true W-2 wages rather than as guaranteed payments. Common sense demands that the mistake of the accountant should not completely alter the calculation of compensation for the pension plan. What PLR is relevant here? I would be curious to review the facts, although I disagree its logic from the summary you presented.

[Lori Friedman]

It sounds as if dmb's been given the unenviable task of mopping up after the fact. We all agree that the client's CPA has done something fishy (that's a nod to you, Blinky), but dmb now has to try to sort out the mess and calculate a retirement plan contribution.

If I were in dmb's situation, I wouldn't make any leaps of faith such as plugging the Form W-2 numbers into Schedule K-1. I'd insist that the CPA amend the LLC's Form 1065 and provide the correct numbers to the members.

Here's a thought -- Did the LLC withhold Social Security and Medicare tax from the erroneous salaries, and did it pay the employer's share? If yes, the client's CPA really needs to fix that problem immediately. This is just one example of why the Form 1065 should be amended before dmb proceeds. I'm guessing that the Form 1065 includes a tax deduction for invalid payroll tax expenses.

[E as in ERISA]

dmb -- I'm always suspect when someone says "similar situation." The other person is probably just saying that there is a ruling in an LLC situation that allows one that it taxed as a partnership to use a W-2 ....but not necessarily the same as here.

It could be that they are referring to Notice 99-6 and progeny. In that there is a limited partnership that owns an LLC that is a disregarded entity. There is a question about how to report to a limited partner that works for the LLC. Pending further guidance, the IRS allowed a couple of different methods. One would allow the disregarded entity to do its own employment tax reporting. I think that would essentially allow the LLC to report the limited partner's earnings on a W-2, even though the LLC's income is effectively reported as partnerhip income on the limited partnership's return. The important fact there is that the LLC is a disregarded entity. And the IRS is still figuring out how to work out some of the glitches based on the fact that these are really separate legal entities but they are ignored for tax purposes. So they have temporarily allowed this treatment. I think that Pub 15-A still supports this treatment.

Your facts are different. You have an LLC taxed as a partnership. No disregarded entity.

I think that you follow the general rule. See the answers to "Who's the Employer" questions 154 and 155 on this web site for a discussion of Notice 99-6: http://benefitslink.com/modperl/qa.cgi?db=...employer&id=154 and http://benefitslink.com/modperl/qa.cgi?db=...employer&id=155

His final recommendation is that when you have incorrect W-2 reporting, you should get the correct self employment income numbers for your retirement plan calculation.