I'm a bit stuck in trying to determine the best way for an investor to get compensated for their efforts in an LLC.
I am part of a 2 member LLC in Philadelphia, PA. Originally, both members were operating under an understanding that responsibilities would be split 50/50 but at this point in time, and for the foreseeable future, I have taken on 100% of the operational responsibilities.
Both members have agreed that I need to be compensated for time and efforts but we are stuck with the best method tax wise and operationally to do so.
Here's the (3) options we currently have...
1) Monthly withdrawals directly from the business account
2) Monthly checks - I believe this would result in me being treated as a 1099 employee.
3) Have a portion of my monthly expenses/bills paid by the LLC. This would include qualifying expenses such as cell phone, office rent, car insurance, and internet.
Aside from the actual method of payment, there is also the discussion of amount. Obviously, any payment I receive would reduce the net profit and therefore market value of the property. The effect on market value isn't a major concern at this point in time. We fully expect to hold all the properties under this LLC for at least 5-7 years.
SO....I'm trying to determine two things...the first is the best method for paying me. This seems to be more of a tax issue than anything. The second issue is determining a fair wage. Our initial thought is to compensate me roughly on the level of of a property manager, i.e. a flat rate of ~12% gross rents.
Any and all thoughts/advice are welcome!
BTW - If this question should be placed in another category please let me know. I'm not certain this is the most appropriate category.
I am not a CPA so this is only me sharing my own experience.
I am also 50% member of an LLC. After consulting my CPA he advised we pay ourselves through "owner draws" We do this by simply writing a check to ourselves. for the agreed/predetermined amount each month.
Your concern for negatively effecting net operating income and therefore dropping the value of the property only applies if your property is a 5 or more unit building. Even if it is 5 or more units, no buyer will be fooled by your proforma saying that there is no expense for management. They will just subtract appropriate expense of PM if you do not.
As for how much to pay yourself. Thats up to you and your partner but I would suggest paying yourself what you would pay a property management company or manager. which would be 6-12% of gross rents. IF you are in a 5 or more unit building, and considering to sell in the coming years then take the lower end to boost NOI.
Hope this helps!
Sturm Home Renovation LLC
I'm in the same situation. 3 member Llc but the other two partners are silent partners. What your looking for is called a guaranteed payment. Google it and read an article about it.
Thanks for the insight. There are currently 5 units in the LLC with an additional 5 coming online mid 2016. Although I left it out of the explanation, I will be managing 100% of the construction that we will be starting first quarter 2016. One of the units is a warehouse we will be converting to 6 units. At that point in time we will potentially need to re-evaluate.
Thanks for the info. I figured this was a common scenario but haven't been able to find much discussion regarding the topic. Oftentimes it's all about expanding your vocabulary and understanding the language of the industry in order to track down what you're looking for!
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Just based on what you typed, I would recommend a guaranteed payment. Do a lot of research and contact your CPA for all the exact details.
Basically, if you do a guaranteed payment, the person receiving the payment is responsible for self-employment taxes which means monthly or quarterly payments to the IRS by the individual may be needed. Since the LLC is just writing a check (and again this is simplified for the purpose of this post) the amount is just an expense to the business and all the burden of taxes falls on the individual.
If you do a distribution, this isn't taxable but instead reduces your capital by as much in the LLC (which if you are the only one taking distributions is probably not what you want). Also distributions are usually based around P&L and since what you are describing is payment for services (regardless of income/loss), if the IRS ever audited you they would almost certainly re-classify them as guaranteed payments and then back taxes and penalties come into play.
You also have the option of setting yourself up to do a real payroll, draw a salary, have the company withhold taxes, etc, but that's a headache in the business that I know I wouldn't want until absolutely necessary.
and everyone else...thanks for the insight and feedback. After reviewing your comments, doing some research on guaranteed payments, and consulting further with my CPA we've decided to do a combination of options 2 & 3.
All of my qualifying business expenses will be paid for directly from the LLC (minimize taxes) and the difference will be distributed monthly as a guaranteed payment.
Thanks again for the help!
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