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Angie
Angie, Tax Preparer
Category: Tax
Satisfied Customers: 225
Experience:  Bookkeeping, Profit and Loss, Balance SheetsAll types of US Taxes, Tennessee taxes, Personal, business, payroll, sales tax etc.
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I am the sole shareholder of an S corporation. I want to reduce

Customer Question

I am the sole shareholder of an S corporation. I want to reduce my SE taxes; can my wife become a shareholder with no active participation and receive shareholder payments from the ordinary income and not be subjected to SE taxes.
Submitted: 9 months ago.
Category: Tax
Expert:  Angie replied 9 months ago.
No...unfortunately, there is a caveat that says this:A shareholder materially participates in an S corporation if the shareholder or the shareholder’s spouse is involved in the corporation’s trade or business on a regular, continuous, and substantial basis (Secs. 469(h)(1) and (h)(5)).
Expert:  Angie replied 9 months ago.
This means that the distributions would be considered from "active participation"...However,you can establish a "regular"payroll and withhold SS and Medicare which will result in half of it being paid (and deductible by) the S corp and the other half withheld, plus you have the option of federal withholding to help cover the FIT.
Customer: replied 9 months ago.
Is there anyway, using an LLC or some other organization form, to distribute earnings to my spouse and avoid paying SE tax on that amount? A friend was advised to form an LLC and he said that he was able make distributions to his spouse and avoid paying SE tax on it.
Expert:  Angie replied 9 months ago.
Yes.... By forming an LLC, you can establish your wife as a "limited partner" and distribute funds to her based on the "repayment of capital" This makes the funds subject to FIT but not SE as she is not an active participating partner. But... In the event of an audit.... they might simply argue that the "assignment of income doctrine" allows them to ignore your structure. The assignment of income doctrine is a judicial doctrine developed by courts trying to limit tax evasion.Or, they might argue that the allocation does not have "substantial economic effect" in which case the IRS would reallocate the income in accordance with the interests of the members in the LLC..The IRS has other weapons in its arsenal, too. So while it appears to be a way to avoid SE taxes, it might be tough to fight if you ever get audited...
Customer: replied 9 months ago.
If I established my spouse as a "limited partner" in an LLC and distributed funds to her based on the "repayment of capital"; wouldn't this require a capital contribution and the amount distributed be limited to the amount contributed?
Expert:  Angie replied 9 months ago.
not necessarily, it does require a contribution, but she can contribute $100.00. If you establish a "limited partner" and establish...giving her ...say 80% of profit or whatever percentage you desire and the remaining percentage of profit to the active partner (you) it will work .