How to reduce self employment tax for flipping project with partners?

Question

It’s been a while didn’t come and post here.:-) hope everyone has a wonderful 2013!

I did a project in 2012 with other two partners (one active on passive no salary for both). By the end of the project I took a small portion as my compensation about $28k (which is specified in the LLC agreement as a percentage of profit before capital distribution). Rest of the profit are distributed per capital contributions, I own capital interest, so I also took about $130k for the profit per capital contribution.

I’m also a realtor so I earned commission when I buy/sell the properties for the LLC. I made about $30k in commission from this project .

Now the issue is about the self employment tax, as I’m manager(active partner) for the LLC, so looks like all of 28k +30k+ 130k are subject to self employment tax. Do I have to pay that amount? Does it make more sense to pay SE only on the 28k+30k? If so will the LLC elect as S-Corp for tax purpose work? If not what’s the reasonable rate to pay?

And for planning purpose, how would you set up the partnership/entities to reduce the SE tax? especially with self capital contribution and with passive partners, I prefer all the profit from capital contribution will not need pay SE tax. While a reasonable compensation/percentage of profit is set aside which will subject to SE and specified in the agreement. Will moving all capital contribution to under my wife’s name and as passive partner work? Will use a LLC to be the manager and I myself as passive partner hold capital interest work? What’s the typical way to set up this ?

Steven Hamilton II · Answer

Richard Z.,

You have to compare every business decision.

-Steven

Richard Z. · Answer

Steven,

I meant to say the LLC was filed as partnership.

Seems in California it need pay 1.5% of state income tax for S-Corp. I need compare the LLC fee w/ the S-Corp state income tax..

Thanks again for all the suggestions!

--Richard

Steven Hamilton II · Answer

Richard Z.,

What do you mean you have filed the first year tax as a regular LLC?

An LLC has no tax status as far as the IRS is concerned it doesn't exist. You have to elect to have it treated as anything other than a partnership or disregarded entity.

You could choose to have the management fee paid to the corporation for doing the work.

-Steven

Richard Z. · Answer

Thank you Steven,

I'm an agent. In this case I do can treat the LLC as a S-Corp. Is it possible/simple to treat the LLC as S-Corp? As we have file the first year tax as regular LLC w/ partners.

So for future projects, if I use another LLC B(treat as S-Corp) to own the share of partnership(regular LLC A), then how about the project management fee part, should I also use LLC B as manager to get the compensation as well?

Steven Hamilton II · Answer

Richard Z.,

Are you a broker or an agent?

Remember that the Social Security portion is capped at $110,100 of earnings. You would pay Medicare on 100% of that as well.

My suggestion is that you are a realtor you treat the LLC as an S-corp OR have an S-corp own your share of the partnership.

My suggestion is that if you are a broker, you could have your brokerage entity own the LLC interest.

There are several strategies that you can employ. One of those would be to have a corporation own the partnership interest. Therefore the income can pass to an S or C-Corp. You could also set up the LLC to be taxed as an S-corp if it works for your situation. As long as you are not partnered with a retirement plan.

Rather than shifting the income from you to your wife, you should just go the route I suggested.

If you have further questions don't hesitate to ask.

-Steven

How to reduce self employment tax for flipping project with partners?

5 Replies