Can the owner of an LLC pay a significant other double in lieu of paying themself? Are there any negative tax implications?

[bhurd4115]

Hi there,

I am an employee of my significant other's LLC. I've been a W-2 employee for 6 years, making a good wage. Due to our growth rate, the business has not yet turned a profit and because of this she shows negative income on tax returns - even though she is also paid well through member draws. This makes buying a home difficult, and I'm curious if there are any negative repercussions to her paying me the equivalent of what both of us make - allowing me to be the sole purchaser of a home? I am aware this would put me in a higher income tax bracket. Note: We are not legally married.

[Critter-3]

Is her business an S-Corp?  Or just a sole prop filing a Sch C? 

[Anonymous_]

---

@bhurd4115 wrote:

....the business has not yet turned a profit and because of this she shows negative income on tax returns - even though she is also paid well through member draws.

---

Is this a single-member LLC? 

"Member draws" do not reduce net profit in this instance.

[Mike9241]

in order for an expense to be deductible it must be ordinary and necessary. This is a determination made by the IRS upon audit. should the IRS disallow a portion of your salary, your SO can object and go to appeals or tax court to settle the matter.  As a single member LLC - schedule C or E reporting the SO doesn't get a salary. they report their income and deductible expenses on the appropriate form. There is no income tax deduction for their member draws. With an LLC taxed as an S-Corp the SO must take a reasonable salary for which they get a deduction on the S-Corp return.

Another possible problem for your SO.  losses over a span of years can be deemed a hobby by the IRS which could result in severe tax consequences. This would be exacerbated with a salary increase for you.

Your remarks raise another possible issue, where is the money coming from to pay the SO draws and your salary and other expenses if it is constantly showing a tax loss.  Though one possibility is large depreciation deductions.

The best thing for you and your SO to do is to sit down with a tax pro and go over the numbers. 

[Carl]

Not sure what is known here. So I'll try my best to clarify. I assume the business is a single member LLC that has not elected S-Corp or C-Corp status with the IRS by filing the appropriate form.

A single member LLC is considered a disregarded entity by the IRS. The owner of a single member reports all income/expenses on SCH C as a part of their personal 1040 tax return. The owner's profit or loss from the business is shown on line 31 of the SCH C. While the LLC  may have employees, owner's draws from the business have no impact on the figure shown on line 31, as the owner does not "pay themself" a wage, and does not issue themself a W-2 or any other type of tax reporting document.

I'm curious if there are any negative repercussions to her paying me the equivalent of what both of us make - allowing me to be the sole purchaser of a home?

After 3 to 5 consecutive years of not showing a profit, it has the potential to "raise eyebrows" with the IRS, as it makes one question how they can stay in business so long, without ever making a profit. I myself have not actually heard of this ever actually happening, but I think it's worth mentioning since you are not married to the business owner and therefor no joint tax return is filed.

You might want to consult with a tax professional (especially if your state taxes personal income) to see if closing the current single member LLC and opening the business as an S-Corp might help in time. The owner of an S-Corp "can" be a W-2 employee of that type of business. But there's a lot more rules to be followed on the tax front with an S-Corp, and that's why a consultation with a tax professional is highly recommended.

[Opus 17]

To be on the safe side, your wages should represent fair market value for the services you actually perform for the business.  They should be similar to the market wage the business owner would have to pay to hire a stranger with similar skills to perform similar work.  

For example, if this is a landscaping company and landscapers in your area are typically paid $20/hour, it would probably raise questions if she paid you $40/hour.  On the other hand, you may be currently underpaid because of the financial situation, and a raise would bring you in line with the market (at least on paper). 

However, aside from the tax situations, I worry about your mortgage lender.  In reality, you are buying a home together.  You are suggesting that you buy the home by yourself, and you show the mortgage lender a W-2 from ABC, LLC showing that you make (let's say) $100,000 per year.  You don't tell the lender that ABC, LLC is owned by your romantic partner and shows a $100,000 loss on its tax returns.  If you did tell the lender all these facts, the lender would realize that the actual money available to the household to pay the mortgage is much less than what it appears on paper.  This is also why a fair market wage may be important.  If your partner goes out of business, you should be able to find another job performing the same tasks for a different business, at the market rate.  If you are being paid an inflated rate, your "income" would drop and the mortgage would be at risk, but if you were being paid a market rate, your salary wouldn't change, just your boss.  Of course, I don't know all the facts, but I would be cautious about this arrangement.