LLC partners draws only making pretax contributions?

[mfs - Jackson]

I have a client that recently converted s corp (solely owned ) to an partnership llc (store manager of 16 years).

This happened 1/18/2018. They had been contributing to a simple ira 3% match. Store manager (who has been taking a payroll check of $65,000/yr)  just told me that she is only taking draws, stopped getting a payroll check upon conversion 1/18/18. 

She is telling me that company tax preparer has no issue with her not taking a paycheck and that she needs to convert company plan to something that would allow her to make pretax contributions without having to take a paycheck (earned income)?  they have not hired someone else to fulfill the responsibilities in the operation.

Any ideas?  Can the partners make pretax contributions and company match 3% on draw?

Is there something I'm missing about her moving to partnership status.stopping the $65k/yr earned income via payroll and only receiving a draw of the exact $65k and not having an explanation of who is the workload? 

Thanks in advance for any guidance.

[Bird]

Sorry but it's kind of hard to follow...um, what does this mean?  ",,,only receiving a draw of the exact $65k and not having an explanation of who is the workload? "

Anyway, it sounds like this individual is your client, and she went from being an employee to being a partner.*  Well, a partner in a partnership can make SIMPLE IRA contributions, so the form of plan is not really an issue.  Somebody probably needs to clean up the paperwork regarding plan sponsorship.  

*Does she know this is a pay cut?

[justanotheradmin]

Separate from draws, her year end earned income will need to be positive in order to have deferrals. 

I have seen partners defer from draws all year long only to discover after year end that there is no earned income from which to defer. Just something to keep in mind. 

[Luke Bailey]

2 hours ago, justanotheradmin said:

Separate from draws, her year end earned income will need to be positive in order to have deferrals. 

I have seen partners defer from draws all year long only to discover after year end that there is no earned income from which to defer. Just something to keep in mind.  

Right. In theory, self-employed person such as member of LLC taxable as partnership can only defer from self-employment earnings. Actual earnings are probably bunched towards end of year, and even if not really can't be determined until after end of year, when tax return for entity and K-1's prepared, so you have to estimate and then true up after end of year. This could in principle be viewed as invalidating elective deferrals made during year from "draws," even if eventually covered by earned income, but IRS included special rule in regs (1.401(k)-1(a)(6)(iv)) to make it OK to contribute from draws. But at the end of the day, elective deferrals on draws in excess of the amount determined as earned income for year would need to be refunded to llc member (the draws in excess of earned income from the year would reduce capital account).

[Bird]

13 hours ago, Luke Bailey said:

Right. In theory, self-employed person such as member of LLC taxable as partnership can only defer from self-employment earnings. Actual earnings are probably bunched towards end of year, and even if not really can't be determined until after end of year, when tax return for entity and K-1's prepared, so you have to estimate and then true up after end of year. This could in principle be viewed as invalidating elective deferrals made during year from "draws," even if eventually covered by earned income, but IRS included special rule in regs (1.401(k)-1(a)(6)(iv)) to make it OK to contribute from draws. But at the end of the day, elective deferrals on draws in excess of the amount determined as earned income for year would need to be refunded to llc member (the draws in excess of earned income from the year would reduce capital account).

All good and understood; I'm a little amused at how you guys are going in the direction of "but you need to have positive income" (implying that there are other profits or losses to be allocated) and I'm interpreting this is a situation where the business changed this employee to a partner who only gets a draw - for perhaps bogus reasons having to do with screwing them.  Maybe I'm reading too much into this (and other posts from new-ish posters).

[Luke Bailey]

Bird, the word "draw" is used to describe advances against profits. These are paid from (1) cash flow that may in fact be profits, but that has not yet been identified as such because the year is not over and accounting is incomplete, (2) line of credit, or (3) capital. I think what you are thinking of is what is called a "guaranteed payment" under Section 707(c) of Code. These occur where all or a portion of what the partnership owes the partner is a contractually set amount, not a percentage share of the firm's earnings. Because those amounts would be owed by the partnership, "come hell or high water," they would be self-employment earnings when paid. BTW, some firms or muddying the waters on the distinction by making their guaranteed payments contingent on the firm's profits, but giving them a priority share of profits, so as to try to qualify the otherwise predetermined amounts for 199A 20% deduction.

[Bird]

Yeah thanks but I'm aware.  Do you really think this "store manager" went from a salary of $65K to being a true partner and getting a draw against profits?  My spidey sense tells me all is not as worded.

[Luke Bailey]

On ‎1‎/‎19‎/‎2019 at 8:48 AM, Bird said:

Yeah thanks but I'm aware.  Do you really think this "store manager" went from a salary of $65K to being a true partner and getting a draw against profits?  My spidey sense tells me all is not as worded. 

I see. You thinking she got slammed into the "gig" economy  so to speak, Bird? Maybe. But seemed like question implied she had been shareholder. Guess original question got what he/she needed, anyway.