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Robin D.
Robin D., Senior Tax Advisor 4
Category: Tax
Satisfied Customers: 14876
Experience:  15years with H & R Block. Divisional leader, Instructor
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I have created a real estate LLC. I have a financial

Customer Question

I have created a real estate LLC. I have a financial partner, who not a member of the LLC. He loans the capital to purchase. We then split the profit on the back. I have been informed that it would be better for him to take interest income on the loan rather than profit split - due to 15% SS Tax. Is this correct?
Submitted: 1 year ago.
Category: Tax
Expert:  Anne replied 1 year ago.

Hi

I'm Anne I've been preparing taxes for 27 years and I'll be helping you today.

It sounds like you have created a partnership with this other individual, and that unfortunately you were given some incorrect advice.

There is always at least 1 General Partner. This is the individual that actually carries on the business (which sounds like you in this business) and THAT person is subject to Self Employment tax, (known as SE tax or SS tax)

The other person in this scenario is what is known as a "Limited Partner". A Limited Partner is someone who invests capital into the business, but does not actually provide any service to the Partnership. This person does NOT pay SE tax on his investment. He is (hopefully) paid back his original investment plus some interest. However, as an investor only, there is no SE tax.

The only excepton to this is "Guaranteed Payments"

Customer: replied 1 year ago.
Thank you. So, if I understand, If we realized $20k net profit and we write him a check for his original loan and a check for 10K for his profit split, I pay the SS Tax but he does not?
Expert:  Anne replied 1 year ago.

Close. You will pay SS tax on YOUR earnings, not on his. His earnings will come back to him SS free.

Expert:  Anne replied 1 year ago.
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Customer: replied 1 year ago.
Not sure your understanding the scenario:
I have an LLC, The financial partner is NOT a member of the LLC. He is making a personal loan to the LLC with a note and mortgage on the property. Parameters are that I pay back the loan and then split the profit with him as additional payoff. So, he receives Principal Loan(No interest) and profit split.We are two completely separate entities
Expert:  Anne replied 1 year ago.
Thank you for that clarification.
If you are two separate entities, then other than reporting any income you give him on a 1099, you are not responsible to decide whether or not he will owe SS tax on any money he receives from you.
That is between his tax preparer & him.
I hope this helps
Expert:  Robin D. replied 1 year ago.

Hello

You posted
"I have created a real estate LLC. I have a financial partner, who not a member of the LLC. He loans the capital to purchase. We then split the profit on the back. I have been informed that it would be better for him to take interest income on the loan rather than profit split - due to 15% SS Tax. Is this correct?"

Your arrangement is a loan with this person so the "profit split" is going to be handled as interest and for this person that is generally better for tax because it is ordinary income and not subject to SS and Medicare (or Self Employment tax) unless he were in the business of making loans.

So your answer would be yes, but the payoff is going to be handled that way anyway because it is an additional amount on the loan you are paying back.