LLCs, S Corp and W2 Income

[diablovox]

My wife and I are both employed full time (W2) + have a 50-50 LLC + have a SMLLC for myself.

Always used Turbotax for all taxes for the last 12+ years.

Questions - 

1. If we never filed a Form 2553, has our LLC been taxed as a normal LLC Partnership so far?

2. If our business income is not more than our W2 salaries, is there an advantage to classifying both our LLCs as S Corps? Or maybe just the multi-member LLC?

Any advice on this would be helpful.

[tagteam · Accepted solution]

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@diablovox wrote:

1. If we never filed a Form 2553, has our LLC been taxed as a normal LLC Partnership so far?

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Yes. A multi-member LLC without an election to be treated as a corporation for federal income tax purposes is treated as a partnership for federal income tax purposes by default.

Note that, as a married couple, you have the option to each report on a separate Schedule C if you hold your interests in the LLC as community property in a community property state, per Rev. Proc. 2002-69.

See https://www.thetaxadviser.com/issues/2019/apr/llc-spouses-partnership-joint-venture.html

[tagteam · Accepted solution]

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@diablovox wrote:

2. If our business income is not more than our W2 salaries, is there an advantage to classifying both our LLCs as S Corps? Or maybe just the multi-member LLC?

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There could be a slight advantage in electing to be classified as an S corporation for federal income tax purposes, but there are also disadvantages (a few of which are somewhat technical).

One disadvantage is you would have to calculate a reasonable salary for services you provide to the corporation as you would be considered an employee of the corporation, rather than self-employed as you would be as a member of an LLC treated as a partnership.

An advantage would be that you might be able to avoid self-employment tax on part of the net income if you elected to be taxed as an S corporation. 

Regardless, you should seek guidance from a local tax professional and/or legal counsel prior to making any decisions along this line.

[Opus 17]

I can't answer what you should do now, but I want to comment on what you should have been doing in the past.

An LLC with 2 members is a partnership and should file a partnership return form 1065.  The partnership return will generate a K-1 statement for each partner that goes on the partner's personal return.

If and only if the two partners are spouses and they live in a community property state, they can choose to file the business as 2 schedule C businesses, one in the name of each spouse, with each schedule C reporting half the income and expenses, regardless of how the work was actually divided.  (It's not clear to me that this is an option, it may be a requirement.  You would want an expert to double check the exact wording of the IRS ruling.) See below.

So if you don't live in a community property state, you should be filing a 1065, and then your personal return would contain 2 K-1s and a single schedule C for your single member LLC.  If you live in a community property state, your past year tax return (and your upcoming 2022 return) should include 3 Schedule Cs, or 2 K-1s and 1 schedule C for the SMLLC.  If 

If this is not what you have been doing, you may need professional help to file the correct amended returns and ask for a penalty waiver.  The penalty for late filing a 1065 is $200 per member per month, and the 1065 is due March 15, not April 15. 

The partnership is automatically classified as a partnership for tax purposes unless you file the form.  As for the benefits and detriments of treating the business as an S-corp, I leave that for others. 

[tagteam]

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@Opus 17 wrote:

....with each schedule C reporting half the income and expenses, regardless of how the work was actually divided.  (It's not clear to me that this is an option, it may be a requirement.  You would want an expert to double check the exact wording of the IRS ruling.)

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The following is clear if you read the Revenue Procedure (2002-69):

If a qualified entity..........and the husband and wife as community property owners, treat the entity as a disregarded entity for federal tax purposes, the Internal Revenue Service will accept the position that the entity is a disregarded entity for federal tax purposes.

The option for interests in an LLC held by a married couple in a community property state is the analog to a QJV (or a regular partnership) where the parties can report their income/expenses in accordance with a mutual agreement.

[diablovox]

Thank you, we're not in a community property state

[tagteam]

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@diablovox wrote:

Thank you, we're not in a community property state

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How have you been handling the reporting for the multi-member (you and your spouse) LLC? 

You almost certainly need to file a1065 (and should have been filing one assuming you did not just organize this entity in 2022).