Tax possibilities for new startup

[profnimrod]

I am a partner for technology smart grid startup setup up as an LLC partnership. At present each partner pays the taxes from the organization ourselves, and we file a K1 (I think it is) at the end of the year - I believe it's referred to as pass-through taxation.

Two things: is this the best way to do this for a company with annual revenues around $1M (for 2018), expecting to be $2-3M for 2019.

Also, I have not been paid for the past 7 years for the many hours that have gone into this startup. We have recently started taking a $2k draw per month, which obviously doesn't come close to paying for the previous years, but also the 200+ hours per month I (and my colleagues) do now. Is there a better arrangement which will minimize my tax exposure?

I should say that I have no problem with paying taxes. What irks me somewhat at the moment, is that we're paying the pass-through taxes, but not being paid (other than the recently started- 3 months ago - $2k per month draws). We're not in any rush to increase the draws to something more akin to a proper salary as we want to re-invest as much as possible into the company while we're in this very early phase and starting to grow.

Happy to do my own research, if someone can nudge me in the right direction.

Many thanks in advance for any guidance.

Kurt

 

[Zigner]

You should seek the assistance of an accountant.

 

[Taxing Matters]

I am a partner for technology smart grid startup setup up as an LLC partnership. At present each partner pays the taxes from the organization ourselves, and we file a K1 (I think it is) at the end of the year - I believe it's referred to as pass-through taxation.

Two things: is this the best way to do this for a company with annual revenues around $1M (for 2018), expecting to be $2-3M for 2019.

That depends on all the details of the business, including exactly what it does, what its income and expenses are, in what state it is organized as a LLC, in what other states (if any) it does business, what the LLC members (the "partners") do for the business, whether the LLC members are citizens/residents of the U.S., in what states the members reside, and what the member's other income, if any, is. I would suggest seeing a tax professional about this, perhaps a tax lawyer given the size of the income and the issues involved. Note that not all lawyers and accountants are knowledgeable about tax; their licenses have nothing to do with tax per se. Whether accountant or lawyer, they need extra education to be knowledgeable about tax. The advantage of the lawyer is that he/she can also advise you on the legal issues involved with whatever changes might be good for tax purposes, something that accountants and enrolled agents (or anyone else, for that matter) are not supposed to do.

It may be that at this point, making the election for the LLC to be taxed as a subchapter S corporation or even C corporation might benefit you and your partners, but without more information I cannot say what would be best for your business. At some point if you wish to sell the business, get additional investors, or go public you may need to convert to an actual corporation under state law anyway.

Also, I have not been paid for the past 7 years for the many hours that have gone into this startup. We have recently started taking a $2k draw per month, which obviously doesn't come close to paying for the previous years, but also the 200+ hours per month I (and my colleagues) do now. Is there a better arrangement which will minimize my tax exposure?

Right now that draw is likely not affecting your tax because you already include in your income your share of the LLC profit anyway. So unless the $ $ 2k/month draw amount is exceeding that share (which after 7 years would mean it hasn't done all that well, profit wise) that draw is likely not a significant issue for you.

I should say that I have no problem with paying taxes. What irks me somewhat at the moment, is that we're paying the pass-through taxes, but not being paid (other than the recently started- 3 months ago - $2k per month draws). We're not in any rush to increase the draws to something more akin to a proper salary as we want to re-invest as much as possible into the company while we're in this very early phase and starting to grow.

The way partnership tax works, very generally, is that the income of the partnership passes through to the partners and that income then increases the partners' basis in their partnership interests. Then when you receive distributions from the LLC, those distributions reduce your basis in your partnership interest. Only at the point that you have fully exhausted your basis in the partnership (which means that your distributions equal the total of what you contributed to the partnership + the income that was allocated to you from the partnership) do you have gain on which you pay tax. So all that income you have received and on which you paid tax has provided you increased basis which means that those distributions you are now getting are basically tax free until you fully exhaust your basis. So you are not getting a double whammy here. Presumably you have not taken distributions because the money has been used to increase the value of the business. That increased basis you have means that if you sold the business today, you'd have less gain on which you would pay tax, too. Thus, there is a benefit to you from this even though you haven't until recently been getting cash in your pocket, assuming the value of the company has grown sufficiently to make it worth the effort.

 

[profnimrod]

Many thanks indeed for your quick response.... and very useful information. I'm an engineering guy, so have been relying on someone else in the company (someone who I don't always think puts the appropriate effort into these questions) to make decisions re organization structure and tax payments... now the company is starting to grow I guess I'm feeling I need to pay closer attention - esp. as ignorance is not a defense ;-) Anyway, thanks once again. I will certainly be taking your advice to find the appropriate expert who can consider our particular circumstances.

 

[LdiJ]

Many thanks indeed for your quick response.... and very useful information. I'm an engineering guy, so have been relying on someone else in the company (someone who I don't always think puts the appropriate effort into these questions) to make decisions re organization structure and tax payments... now the company is starting to grow I guess I'm feeling I need to pay closer attention - esp. as ignorance is not a defense ;-) Anyway, thanks once again. I will certainly be taking your advice to find the appropriate expert who can consider our particular circumstances.

Another thing to consider: What many partnerships will do, if there is money available, is that they will distribute to the partners, at tax time, enough money to cover the tax they have to pay on the pass through income. That would be a distribution in addition to the 2k draw you are currently receiving. That would be a kind of compromise that would allow you to leave most of the profits in the business, but not be personally strapped for cash to pay the taxes at tax time.