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AUGUST 2004

LLC OWNERS:SMART MOVES CAN TRIM SELF-EMPLOYMENT TAXES

Limited liability companies (LLC’s) have become the entity of choice for many businesses. That's largely because LLCs combine the S corporation benefits of flow-through taxation and limited liability along with partnership-type flexibility for distributions and ownership interests.
But the news isn't all good. Operating as an LLC rather than an S corporation carries downsides. Specifically, LLC members (owners) are treated as partners and are, therefore, subject to self-employment (SE) tax.
In 2004, the total SE tax rate is 15.3%. Breakdown: Social Security portion of the tax (12.4%) is applied against the first $87,900 of earnings. The Medicare portion (2.9%) applies to all SE income, without limit.
Wiggle through partnership loophole
The SE tax applies to most trade or business income. But certain items are excluded from the tax, including real estate rentals, dividends, interest and limited partners' shares of partnership net income.
That last exclusion-limited partners' profits-might provide you an escape from SE tax if LLC members can be considered limited partners. No definitive IRS guidance exists on this topic, but the IRS did issue proposed regulations in 1997. The regulations, in effect, say you can be treated as a limited partner for SE tax purposes by meeting all of these conditions:
1. You must avoid personal liability for the LLC's debts.
2. You have no authority to contract on behalf of the LLC.
3. You participate in LLC's operations 500 hours or less during the year.
Note: If your LLC offers services in health, law, engineering, architecture, accounting, actuarial science or consulting, none of the service providers will be considered limited partners for SE tax purposes.
2 ways to qualify as limited partner
1. Divide and conquer. You could segregate your company's business activities into separate LLCs. If you provide less than 500 hours service to each separate LLC and non-manager member, you'll likely meet limited partner tests, and your income will not be subject to SE tax.
2. S may stand for savvy. You could form an S corporation to hold your LLC interest. Then the S corporation could lease your services (as an employee of the S corporation) to the LLC.
Any salary paid to you by the S corporation would be subject to Social Security and Medicare taxes. But neither your share of LLC profits paid to the S corporation nor your share of the S corporation's profits would be subject to SE tax.
Source: Research Recommendations  

YOU CAN’T FORCE ESTRANGED SPOUSE TO FILE JOINTLY

Q. My wife and I lived apart for 2003, but we weren’t legally separated. I think she filed a separate tax return for 2003 claiming our two children as dependents. Can I still file a joint return?
A. No. If your spouse won’t agree to file a joint return with you, you’ll need to file separately. While you’d probably be better off tax-wise by filing jointly, you cannot force your spouse to consent to a joint return. TIP: In most cases, the spouse with custody of minor children is the one who can claim the dependency exemptions. If both you and your spouse claim exemptions for your two children, it will raise a big red flag at the IRS.
Source: Research Recommendations

COMPANY CAN CONTRIBUTE TO YOUR ROTH IRA

Q. Our small company does not have a retirement plan. Can the company contribute to a Roth IRA on my behalf if I’m one of the company principals?
A. Yes. A company may contribute to a Roth IRA or traditional IRA (or combination of both) for an eligible employee up to the annual limits for such IRAs. The current limit is $3,000 per year. But any employer-paid contribution must be treated as compensation for tax purposes. The contribution is also subject to payroll taxes. In effect, it’s as if you were paid extra compensation and made the contribution yourself. Depending on your income, you may be able to deduct all or part of a company contribution to a traditional IRA. All things considered however, it’s a whole lot easier to make IRA contributions on you own, rather than through a company plan.
Source: Research Recommendations

WHO PAYS THE MOST INCOME TAXES?

The individual income tax is highly progressive, meaning a small group of higher-income taxpayers pay the great majority of individual income taxes the IRS collects each year. How progressive are we talking about? A new IRS study sheds some light on the subject.
It says taxpayers who rank in the top 1 percent of highest-earning Americans will pay nearly one-third (32.3 percent) of all federal individual income taxes this year. The top 5 percent of earners will end up paying more than half (53 percent) of all income taxes. Here’s a full breakdown:

Income Level Share of Income Tax Burden
Top 1% of taxpayers 32%
Top 5% of taxpayers 53%
Top 10% of taxpayers 65%
Top 25% of taxpayers 83%
Top 50% of taxpayers 96%
Bottom 50% of taxpayers 4%

Note: President Bush’s tax cuts have shifted a larger share of individual income taxes to higher-income taxpayers. In 2004, when most of the tax cut provisions take full effect, the projected share of income taxes for lower-income taxpayers will fall, while the tax share for higher-income taxpayers will rise.
Source: Research Recommendations

Caution  Do not adopt any of our recommendations without consulting a tax professional

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