Multi-member LLC paying member dividends vs employment

[Halfwinter]

This year I structured my LLC in Tennessee (where I moved) as a multi-member and took a 50%/50% partnership with another individual. We're finally building our clients and making money 😅. We're paying our contractors as vendors, and we're assuming we (the partners) can draw money from the business account at our discretion because from a tax perspective 50% of the business account balance is our individual property right? There are a few questions lingering:

1) Should quarterly estimates come from the LLC under our EIN, or from us individually as partners using our socials?

2) At the end of the year we're both individually responsible to pay taxes on 50% of our revenue right? How do we track joint deductions (fees, subscriptions, payments to contractors.. etc)? Do we just divide each sum in half?

3) If we're using dedicated contractors, should we be employing them? Would there be any benefit to our restructuring our business and employing ourselves?

4) My partner lives in NY and I live in TN. I set up the LLC in TN, but should I consider having it in another state?

ty!

[DawnCo]

Hi

Great questions. Understanding Business Structure, Bookkeeping and Taxes is super important when going into a business venture.1) Should quarterly estimates come from the LLC under our EIN, or from us individually as partners using our socials? A Multi Member LLC is a pass through entity, meaning income flows through to individual partners. Estimated taxes should be paid at individual level with each partners SSN.

2) At the end of the year we're both individually responsible to pay taxes on 50% of our revenue right? How do we track joint deductions (fees, subscriptions, payments to contractors.. etc)? Do we just divide each sum in half? The partnership should be using bookkeeping software like QuickBooks or an excel spreadsheet to account for all expenses, income and distributions to partners. A partnership or LLC files its tax return on Form 1065. Each partner receives a Form K-1 from the partnership. K-1s report each shareholder's allocation of income, losses and other financial information from the business. The shareholder includes Form K-1 information on their individual tax return.

You will do a Business tax return for partnership. This is where expenses, income and distributions to partners will be accounted for. The business return will create a K1 for each partner. This will be used in individual return to report your share of income.

3) If we're using dedicated contractors, should we be employing them? Would there be any benefit to our restructuring our business and employing ourselves? Dedicated contractors should be issued 1099's at end of each year. If they contract on job to job basis, they are contractors. If they are on a time clock they should be employees. Restructuring: Doing an scorp election and both partners being w2 employees could save of on self employment taxes. How this works is you have each partner get a reasonable salary and any money distributed to partners outside of W2 income would only be taxed at ordinary income

4) My partner lives in NY and I live in TN. I set up the LLC in TN, but should I consider having it in another state? The issue is not where you have it registered. Understanding tax implications for each state s important. Like NY partner is NY resident. They will file individual resident tax return on all money earned. TN partner would file NY non resident tax return on all money earned in NY only.

[DawnCo]

Here are some helpful Links

Bookkeeping: https://quickbooks.intuit.com

Business Returns: https://turbotax.intuit.com/small-business-taxes/

Tax Guidance: https://turbotax.intuit.com/tax-tips/irs-tax-forms/what-is-form-1065/L5UpOREHb

Scorp electionhttps://turbotax.intuit.com/tax-tips/small-business-taxes/can-i-convert-my-llc-to-an-s-corp-when-filing-my-tax-return/L7MHL5wVo

I would love to answer any more questions you have. Just reply with additional guidance or clarification needed. Have a great day!!

[Halfwinter]

Thanks so much for the excellent comments and resources. 

1) makes perfect sense. ty for confirming

2) ty for information on K-1s. I'll do some research on how to properly report in our bookkeeping software.

3) When you say making partners W2 employees could save on self-employment taxes, could you expound on that a little bit? My understanding is that if roughly a third of our gross income goes to taxes as self-employed partners, employees would pay roughly half that (a sixth deducted from checks) and the employer (us) would pay the other half (+unemployment and other taxes/fees). Is that accurate? Is the total sum of taxes paid from income the same, just divided among employee and business? If so, per questions 1 & 2 above, as self-employed partners, we can reduce that burden by deducting our personal investments and home office etc. As employees, I'm assuming the business would be the only entity making those deductions. Are there other benefits to employment that I'm not thinking of?

4) It seems like each state can make establishing a native business really easy (when I lived in MN it was super easy and cheap, like $100 to register and then free to renew each year) or really hard (NY seemed to cost several thousand a year just to register or renew). Tennessee is somewhere in the middle—registration/renewal is $300/yr, but there's this "excise tax" that I don't totally understand... Since both partners live in different states, one or the other will need to accept income from a foreign entity right? So is there any benefit to just making the business a foreign entity in a state that makes it easy (I hear Delaware is a popular choice)? Or is that misguided?

[DawnCo]

Question 1

 When you say making partners W2 employees could save on self-employment taxes, could you expound on that a little bit? My understanding is that if roughly a third of our gross income goes to taxes as self-employed partners, employees would pay roughly half that (a sixth deducted from checks) and the employer (us) would pay the other half (+unemployment and other taxes/fees). Is that accurate?

Yes this is accurate.

Is the total sum of taxes paid from income the same, just divided among employee and business? If so, per questions 1 & 2 above, as self-employed partners, we can reduce that burden by deducting our personal investments and home office etc.

This is correct. You can deduct unreimbursed expenses during input of K1. The program will ask: do you have any unreimbursed expenses ( home office etc) from partnership.

As employees, I'm assuming the business would be the only entity making those deductions. Are there other benefits to employment that I'm not thinking of?

As your business stands right now. I see no benefit of being W2. It is a simple pass through entity. It is set up with it's own benefits. 

What I was referring to was making an scorp election for your partnership! It's something to look at. This does come with additional compliance steps as far as taxes and payroll. If you organize your business as an S-corporation, you can classify some of your income as salary and some as a distribution. If you organize your business as an S-corporation, you can classify some of your income as salary and some as a distribution. You'll still be liable for self-employment taxes on the salary portion of your income, but you'll just pay ordinary income tax on the distribution portion. Depending on how you divide your income, you could save a substantial amount of self-employment taxes just by converting to an S-corporation. Here is a good article explaining in more detail.  https://turbotax.intuit.com/tax-tips/small-business-taxes/how-an-s-corp-can-reduce-your-self-employm... 

Here is an article on how to do it. https://turbotax.intuit.com/tax-tips/small-business-taxes/can-i-convert-my-llc-to-an-s-corp-when-fil... 

Your partnership is just getting established. You are learning bookkeeping and taxes for partnership. This is great. Once you have gotten bookkeeping and Business taxes Understood and in compliance, I would look into scorp election for a future tax planning.  

[DawnCo]

Question State tax implications

State taxes can be very complicated you are right. To answer this part, I will need more information. 

Where are you actually doing business or services? 

[Halfwinter]

Thanks for that info! I am based in TN and my partner is based in NY. We currently have a contractor (that should probably become an employee) in FL, and a contractor in PA. All our work is services oriented and remote. We have a client in IL, CA, and NY. Is that the right level of background?

[RobertB4444]

Your state taxes will be done in the headquarters of the company then.  That seems to be Tennessee.  So the corporation needs to file any required forms in Tennessee and make certain that it is registered in Tennessee.  Since you are a service based business that's all that is required.

If you convert your contractor in Pennsylvania to an employee you'll need to with hold state taxes for them as well as federal.  You can handle payroll yourself with a service like Quickbooks since you'll only have the three employees.  

@Halfwinter