I'm a research scientist in a tech startup company (LLC). I received common share units as employee incentive.
In the K-1 form I received. Box1: Ordinary business income (loss) , there is a net loss.
When i used TurboTax to enter my K-1 form, there is a question asking whether I "materially participated in the partnership's business activity" The answer (Yes/NO) makes a huge difference (several thousand$) in the nonpassive loss amount (reduces taxable income).
If by working hours, I'm definitely over 500 hrs a year. But EasyGuide seems to imply only the higher management who can make big decisions in the company are considered to "participate" in business activities.
There should plenty of people out there who received employee stocks in LLC companies. I wonder how you answered to this question in Turbo Tax.
i have provided a link to PUB 925. on page 5 you'll find what the IRS considers material participation
in the context of an LLC there are no limited partners only LLC members.
Additional information needed:
- Are you being paid W-2 wages (want to understand if things are being handled properly)?
- Did you invest any initial capital in this entity?
- Did you pay any $$ for the units received?
- Is there a vesting schedule?
So I have a number of comments based on your follow-up responses:
- As a member of an LLC that is taxed as a partnership (form 1065), you cannot be an employee. As such, you should not be paid with W-2 wages. This in itself is a problem and needs to get resolved. Members of an LLC that is taxed as a partnership receive renumeration via what is called a guaranteed payment and this amount is reported as a separately stated item on the respective K-1.
- Just based on my first bullet, someone should get a tax professional involved to make sure you don't compound the payroll matter problem and get you started down the right path.
- If you are working for the LLC full-time, more than 500 hours as you stated, you are most likely classified as a material participant.
- Going into the next issues gets more complicated and once again a tax professional should be consulted.
- If you received LLC units without paying any $$, then I assume these were received for your services provided. There needs to be written documentation on the issuance of these units. While the facts are limited, and this forum is not conducive to going into detail, you most likely received what is known as a profits interest (versus a capital interest). This distinction is important as one is taxable (capital interest) and the other is not.
- Since you indicated you did not invest any initial capital and most likely received a profits interest, you will not be able to use the loss currently. The reason for this is that a member needs to know their outside basis and at-risk basis; these are not generally the same. You are only able to take losses currently to the extent that you have at-risk basis, which it appears you do not have any at-risk basis; any unused losses will be carried forward indefinitely.
- As a follow-up to the first bullet, if you are a material participant in the LLC there is an issue of SE Tax on the income being passed through to you. This is not a clear cut and dry issue in some cases and this is another area that you should get some tax advice. This is a big issue as well.
- So as you can see, regardless of the size of an entity, in your case an LLC, issues can become complicated quickly and the need for a tax professional is evident.
Just to clarify, the units I received have no real value b/c our company is private and the units are not trad-able; and our company don't have any profits yet. So I don't agree with "should not be paid with W-2 wages".
You are probably right. I better consult with a CPA instead of looking for advice here.
But thank you all the same.
Whether or not the units are traded on an exchange has no bearing. All companies have a value regardless of being public or private. That is the whole premise behind the profits interest and capital interest. A profits interest has no bearing on the profitability of the entity when issued.
You can certainly disagree with my statement that you should not be paid via W-2. Just that I have over 25 years in tax, specialized in the partnership tax area and have taught partnership tax. So I do believe I know this area.