๐๏ธ Weekly emails ๐๏ธ Accounting Basics ๐ฐ Tax Strategy and Structuring Basics ๐ Internal Controls for Small Business ๐ญ Lessons learned as a partner and running CPA Firms
S-Corps and LLC Operating Agreements - A Match Made in Hell
|
The most flexible type of entity, from a federal tax angle, is the LLC. ๐งโโ๏ธ The LLC is a shape-shifter of business types, which is great for a lot of different reasons. But it's not so great when it's not respected. โ When an LLC is going to be used as an S-Corp with multiple owners, there is an extra layer ๐ฐ of attention that must be paid to the LLC Operating Agreement (OA). Disregarding the OA language can result in a busted S-election and a C-Corp with years of back taxes. ๐ค When this happens to the S-Corp, all bets are off. ๐ฐ Unfortunately, this is often discovered in tax due diligence and can blow up deals faster than actual fraud being discovered. Let's dive into why it matters, what to look for and some possible solutions from the IRS. โ Why It Matters For an S-Corp to be an S-Corp, it must follow several rules to qualify and keep that status:
The problem is normally the last item. Many shareholders and business owners usually take this to mean that all distributions are pro-rata (e.g. a $100 distribution is paid out $70 to a 70% shareholder, and $30 to a 30% shareholder). While that's not wrong, it's not the full picture. The IRS weighs both (1) did you pay out non-equal distributions, and (2) what does the OA say. โ๏ธ That means even if you kept distributions fully in compliance, if the OA makes reference to more than one class of stock you're in a bad S-Corp position. The opposite is also true. You can have good S-Corp language in the OA but are making non-pro rata distributions and still be in violation. You need to be a good S-Corp in appearance and in fact. ๐ฆ
What to Look For Attorneys are not always up on this nuance. ๐ฉโ๐ผ They'll advise that this is why your CPA needs to review the OA and weigh in on any tax concerns. But this is more than tax concern, this is a foundational issue with S-Corp OAs. Getting this wrong means the entity is set-up incorrectly from the start. ๐ โโ๏ธ So what exactly should you look for when the attorney sends you the OA draft to review? ๐
It's worth nothing that different voting rights don't necessarily mean separate classes of stock for the S-Corp. But still something to keep an eye out for as voting and distribution often are planned together. ๐ฟ
How to Fix It If you have either disproportionate distributions OR bad OA language, Rev. Proc. 2022-19 will be your go-to guide and friend. ๐ซ In this guidance, the IRS gives some direction on how to remedy these kinds of busts - which in itself is signal that this is happening A LOT. In short:
The tl;dr of #2 is that if you have bad OA language AND made disproportionate distributions then you're S.O.L. ๐คทโโ๏ธ and have a C-Corp with back taxes. If this is you, I suggest you work with a tax specialist at a large firm and your attorney. There are people who do this all day every day because it's such an issue.
The maxim that an ounce of prevention is worth a pound of cure definitely applies here. โ๏ธ Get the wording right from the start and keep distributions proportionate to avoid all this drama on the back end. โ ๐ซก
๐จ๐จHave a Question - send a reply directly to this email and I'll answer it in upcoming emails ๐จ๐จ Have an idea for a newsletter? Would love to hear from you. Want a deeper dive on anything above? Let me know! Want to read previous issues? Click here.โ If you enjoyed this, please forward on to a friend and let me know on X / Twitter. |
The Plug: Tax & Accounting for Real Estate and Small Business
๐๏ธ Weekly emails ๐๏ธ Accounting Basics ๐ฐ Tax Strategy and Structuring Basics ๐ Internal Controls for Small Business ๐ญ Lessons learned as a partner and running CPA Firms
Interest expense is a part of life for nearly everyone. Unless you're a die hard Dave Ramsey (no hate here) ๐ด๐ป, you likely pay interest expense on your mortgage ๐ก, credit cards ๐ณ, and auto loans ๐. And it's no less prevalent in business. Prior to 1986, all interest expense paid was generally deductible by everyone - people and businesses. Which, if you've ever looked at an interest rate chart for the 1980s, you'd see why this became a serious revenue raising opportunity for the IRS ๐ Cue the...
Today we will be taking a pretty deep dive into an ownership structure common in real estate - the Tenancy in Common, or TIC. ๐ข This may be overly deep if you don't care about real estate tax structuring - but it's exactly the thing I nerd out ๐ฅธ about and enjoy so it's what you get today! Below, we'll talk about: What a TIC is and how it's used ๐คทโ๏ธ What are the (lesser-known) rules to run a TIC for tax compliance ๐ What does tax filing look like for TIC and TIC owners ๐ ๐จ Before we dive too...
Every Cash Flow Statement I've seen from an accounting software sucks (looking at you, QBO)๐ฟ. It's a shame because the Statement of Cash Flows (SCF) is one of the most practical financial statements to really understand the health of a business. ๐ฉบ If you read the breakdowns of the downfall of Enron, the SCF and related party disclosures were throwing red flags ๐ฉ years before it all came down. So what is the SCF and how can you use it? Let's dig in ๐ I created the meme above to demonstrate how...