On 3/6/2022 5:27 PM, D L wrote:
A sole proprietorship is taking on a new partner. Since both persons are still in an early startup phase, they need to decide on a startup business entity structure. Under consideration is a California LLC and a decision needs to be made how to tax the
LLC as a partnership or S-Corp or C-Corp. It goes without saying that liability is a major consideration and simplicity, lower overhead, and lower taxes are key considerations. If The LLC taxed as an S-Corp pays lower taxes and the members are not
considered employees like a C-Corp, would the members pay less income taxes and avoid California workers' comp?
Thanks.
I believe the issue of members and employment income vs
dividends/distributions is the same for partnerships, S-corps and
C-corps. If a member performs services for the entity, they must be
paid wages, although those wages need not necessarily be their entire
income from the entity. Reasonableness applies, and the wage portion of
their income must be a reasonable wage given their services provided.
This is a major point of contention with the IRS for many entities,
perhaps because they attempt to low ball the wage portion of the income.
I think the members would pay the same California income tax for wage
income or non-wage income from the entity.
As to workers comp, I am not an expert by any means, but see California
Labor Code sections 3351(f) and 3352(a)(17):
3351.
“Employee” means every person in the service of an employer under any appointment or contract of hire or apprenticeship, express or implied,
oral or written, whether lawfully or unlawfully employed, and includes:
(f) All working members of a partnership or limited liability company
receiving wages irrespective of profits from the partnership or limited liability company. A general partner of a partnership or a managing
member of a limited liability company may elect to be excluded from
coverage in accordance with paragraph (17) of subdivision (a) of Section
3352.
3352.
(a) “Employee,” excludes the following:
(17) (A) An individual who is a general partner of a partnership or a
managing member of a limited liability company who executes a written
waiver of his or her rights under this chapter stating under penalty of
perjury that the person is a qualifying general partner or managing
member. The waiver shall be effective upon the date of receipt and
acceptance by the partnership’s or limited liability company’s insurance carrier. The insurance carrier, with the consent of the individual
executing the waiver, may elect to backdate the acceptance of the waiver
up to 15 days prior to the date of receipt of the waiver. The insurance carrier, insurance agent, or insurance broker is not required to
investigate, verify, or confirm the accuracy of the facts contained in
the waiver. There is a conclusive presumption that a person who executes
a waiver pursuant to this subdivision is not covered by workers’
compensation benefits.
You might want to check the rest of section 3352 to see if anything else applies.
Do not overlook the new California PTE tax scheme which serves as a work
around for the federal SALT deduction limitation. Depending on the
income level of the entity and individuals, this may or may not work as
a significant savings on federal individual income taxes. If so, this
would lead to you opting not to tax the LLC as a partnership, but as a corporation, most likely an S-corp.
Here are a couple links, there are others:
https://www.ftb.ca.gov/file/business/credits/pass-through-entity-elective-tax/index.html
https://www.eisneramper.com/knowledge-center/articles/tax/california-pass-through-0821/
https://www.pwc.com/us/en/services/tax/library/california-makes-changes-to-pte-tax-and-2022-nol-credit-limits.html
I think the advice given to seek guidance from a knowledgeable
professional is good advice. Who knows what else you should be
considering given your specifics, and even your plans for the future.
But I think you are asking good questions, and now is the best time to
be asking those questions, and getting that professional advice.
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