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PDtax
PDtax, CPA firm owner
Category: Tax
Satisfied Customers: 1920
Experience:  32 years tax experience, including four years at a Big 4 firm.
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I am a partner in a TX LLC. My partner has been in charge

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I am a partner in a TX LLC. My partner has been in charge of the books(I know, big mistake). It has recently come to my attention that for about a year now, she has mis-categorized disbursements to herself as taxable income. She fulfilled work for a few of our clients and I agreed that she could take 100% of that revenue in compensation. Those payments ran through the company accounts. She then had our bookkeeper process these payments (approximately $23,000) as taxable salary. Now, the company paid employer taxes on this income over the last year. Additionally, this looks like revenue on the books, so of course it will appear to the IRS as income.

We are dissolving the partnership and in dispute about what each of us owes the other. What, if any, are the standards of practice regarding this? How might I make a legal argument regarding the improper categorization of 'disbursements' vs. 'taxable salary' to present my side that she owes the company the employer taxes and we should have been issuing 1099 for those disbursements? What do I do about the Income tax issue? Lastly, can you point me to tax law or how to research business tax laws to support my position? Thank you!
Submitted: 1 year ago.
Category: Tax
Expert:  PDtax replied 1 year ago.
Welcome to the site. I will be helping you today.

I need some more insight into how the LLC reports more income than it should have. If she allocated the profits on those jobs to her as salary, that's deductible by the LLC. The payroll taxes would be as well. And, since you agreed that she could claim all of the revenue, it had to come out somehow.

An example will explain my question. Let's say your LLC did $30,000 in business, and had $5,000 in expenses. You agreed your partner could claim $23,000 as income earned, so it was reported as wages, a deduction. Let's add $2,000 or so in payroll taxes and insurances. In this example, you would be splitting $0 LLC profits, and she would report $23,000 in income.

I also don't follow the disbursements issue as income. Please advise with a bit more background.

I can offer some preliminary advice. Instead of trying to determine what your piece of the business is worth, and how the math may not be in your favor, decide what you want for your interest and ask for it.

I will be glad to assist in outlining the litigation side of your question, once I understand it a bit more. One of my favorite techniques is using the court system to expose the financial irregularities, almost guaranteeing an IRS examination (which would correct the tax problem without you demanding same. You can also do this by disputing the amount of income to report from the LLC, without going to court.

Customer: replied 1 year ago.

Thank you for your reply and willingness to help. I hope I can answer your questions. I do not understand your questions actually...


 


I think I'm following you in regards XXXXX XXXXX it doesn't matter that she took 100% - it's part of the revenue and that's taxable income. Okay.


 


The disbursement issue -


 


The other partners do not take 100% of any funds. We have reimbursements but we do not have any A/R where we take 100% of the revenue. I did end up getting a small 1099 last year from the company, but I believe it was for a reimbursement and thus wrongly 1099'd.


 


I think I need help understanding either business tax process or law regarding how a company classifies salary versus 1099.


 


My accountant said that as an LLC we can and should be categorizing the direct disbursements as just that - disbursements. But the salary and commissions we pay employer taxes on.


Can you help?


 

Expert:  PDtax replied 1 year ago.
I can.

The best way to understand what happened is to use an example like I set out for you, then add your facts. Once you see what went in and came out, what you should be allocated will become clear.

Paying out of a partnership (LLC) beyond the partnership agreement requires a method to do it. Your LLC uses both salary and 1099 to make specific allocations, which I assume you allow in your partner agreement. That document will drive any disputes in court, so a review, making sure it is allowed, is imperative.

If special allotments of income, expense, profits, etc. aren't allowed in your agreement, you can argue the payment is not correct (I know you agreed verbally - it just may not be allowed to verbally agree to amend your partner agreement).

The only way to make special allocations to one partner is to pay out via 1099 or salary.

Since you are in dispute, I suggest you request a complete copy of the bank records. In the alternative, copies of your bookkeeper's workpapers will lay out your questions in more detail. Your agreement will spell out your rights to records.

Your bookkeeper has told you of the improprieties; allow her to explain to you what the income should be versus what it is. Her work will be the first records I would get to start my inquiry.

The next is your LLC agreement. Review it carefully for the calculation of income sections, rights to records, who is the Tax Matters partner (who signs the return for the LLC).

Once you have a sense of what the issues are and can identify them in your records, you can file a Form 8082 (Report of Inconsistent Treatment or Administrative Adjustment (link: http://www.irs.gov/pub/irs-pdf/f8082.pdf) to report only the income or loss you believe you should report. IRS will investigate and determine a resolution of the issue.

You might also consider taking protective steps about your ownership. An attorney's services may be needed, unless you can come to a settled amount for a buyout or turn-in of your ownership interest.

I know there's a lot here, but you really need to review your situation with a tax pro, and possible a litigation attorney if your dispute goes that far. The records I suggest you obtain, along with an affidavit from your bookkeeper, will be the initial steps needed by the CPA or attorney or both you consult.

Sadly, many of these disputes cost more than they ultimately would pay out, so a cost-benefit analysis should be done in deciding how to get the most value for your investment.

I hope that gives you the 'next steps' to take in building your case and reporting correct income for 2012. Thanks again from Just Answer/Pearl.
Customer: replied 1 year ago.

Thank you, Pearl. This is helpful.


- We do not have an operating agreement. So, everything is based on verbal and the history of how we've been doing work. (Yes, shame on me!)


- I have hired an attorney and we have a pending suit, thus my research.


 


You mentioned -- "...assist in outlining the litigation side of your question, once I understand it a bit more. One of my favorite techniques is using the court system to expose the financial irregularities, almost guaranteeing an IRS examination (which would correct the tax problem without you demanding same. You can also do this by disputing the amount of income to report from the LLC, without going to court."


 


Can you point me in the direction to understanding this better?


 


Let me know when or if our dialogue gets too long and I should resubmit so that you are properly compensated.


Thank you!

Expert:  PDtax replied 1 year ago.
If you don't go to court, filing Form 8082 will invite an IRS inquiry into the income tax return and allocations. IRS will do much of your work for you.

If you do go to court, and disclose in open court that there are financial irregularities, most courts answer a compulsion to report the matter to IRS, who often audit the returns in question (without your actually filing the 8082). Things like payroll, insurance, unemployment and the like are also likely to be reviewed just by going to court and mentioning under oath that you believe the tax returns are incorrect in your partner's favor.

I appreciate the offer of additional compensation. You can close out this question with positive feedback and a bonus if warranted. If you want to ask additional questions, ask for me, PDtax, in the first sentence of your request and I will be alerted. Thanks again, and good luck.
PDtax, CPA firm owner
Category: Tax
Satisfied Customers: 1920
Experience: 32 years tax experience, including four years at a Big 4 firm.
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