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I am younger than 59 years old. I used to run a sole proprietor

business, generated earned income, filed...
I am younger than 59 years old. I used to run a sole proprietor business, generated earned income, filed a Schedule C, and maxed out on sole 401(k) contributions, and I also contribute to an HSA account.

However that business has faded out almost completely.

Currently my main activity is managing my own investments: stocks, bonds, rental real estate, and membership in an LLC that invests in commercial real estate. In reality, this is all passive income.

I am married, file jointly but spouse currently does not work, and we have two minor children.

According to IRS rules, can I set up some sort of entity - LP, LLC, S-Corp, trust - that would allow me to pay myself a reasonable management fee that I could declare on a Schedule C through which to continue paying FICA taxes and continue to make sole 401(k) or other retirement account contributions?

Or, no matter how I slice it, is it all considered passive income as per IRS rules?

Thank you.
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Answered in 57 minutes by:
9/4/2013
PDtax
PDtax, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 4,711
Experience: 35 years tax experience, including four years at a Big 4 firm.
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PDtax :

Welcome to the site. I'm PDtax, and will be helping you today.

PDtax :

The good news is I can think of ways to set your investment and LLC income up as wages and/or self employment income for the 401(k) and FICA contributions you want. While this is contrary to standard planning, it makes sense if your FICA contributions would increase your benefit for when you retire, and of course establishes a wage base for 401(k) contributions.

PDtax :

Both investment income and earnings from a real estate LLC are not typically considered self-employment. The investment income is likely portfolio income (not a self-employment generator, but can be) and the LLC earnings might be passive income. Both can be modified to establish a base for the 401(k) and FICA tax payments you want to make.

Customer:

Hi,

Customer:

I would be more interested in self-employment income, not wages. Yes, the investment income is portfolio income and the rental real estate is passive income. However, I do manage both personally.

PDtax :

Hi. I was just looking at what might be required for making your investment management a wage or self-employment activity. Are you actively managing your own investments?

PDtax :

What I mean, do you trade, even infrequently, or are you a buy and hold investor?

PDtax :

bear with me, dog needs to go out, back in a few minutes...

Customer:

I am willing to pay you an extra fee and give an "excellent" rating if you can provide a little detail on why it is not standard planning practice? Is it simply because I would probably pay less tax on dividends and other passive income as compared to FICA tax? but, in any, case what kind of legitimate structure could I set up to generate "fee" or "advisory" or "administrative services" income that

Customer:

Sorry. I hit the reply button by mistake. No, I am not a trader, but I do personally manage my stock/bond portfolio and rental property and do the accounting for the LLC interest.

Customer:

To finish my sentence, what kind of legitimate structure could I set up to generate "fee" or "advisory" or "administrative" income that I could report on a Schedule C (no wage or salary income, that would seem too complicated).

Customer:

Since I am not a trader and, hence, the answer is that I can do nothing about it, or that it would b too complicated and cause other problems, that's okay.

PDtax :

Standard planning practice would be to reduce the FICA tax cost, not increase it. Nothing more involved than that. Since you need self-employment income (a wage might be easier from the LLC, but this can work as self-employment too), the planning is reversed from standard.

PDtax :

Trading can be a business. I was reviewing some of the benchmark self-employment cases, and for atypical activities like trading, gambling, etc., one of the keys is volume or frequency of management.

PDtax :

Let's get back to that in a moment. The easiest way to get some self employment income is to report payments from the LLC for services rendered (on Sch. C). The LLC gets a deduction, shared with all, and you get self employment income. Tax prep, bookkeeping, management can be paid to you separately via 1099. Check your LLC agreement to insure this will be allowed.

Customer:

Since I have no "job", have no other source of retirement contribution, and I am less than 59, I do not mind paying into social security and being able to make more retirement contributions over the next 10 years or so. I have researched the definition of trader and I definitively do NOT qualify. I do not yet have an LLC set up for this specific purpose, but the members would be myself and either family members or a family trust. Do you

Customer:

Sorry. Let me finish. Do you think there would be any problem with what you suggest for the LLC if it is a single member LLC or a family-owned LLC? Finally, can you cite any IRS publication or sections of the tax code that I might research more in detail?

PDtax :

A single member LLC is treated as a disregarded entity for tax purposes, and the income generated is very often self employment income (the LLC results are reported on Schedule C for the owner of a single member LLC). Family LLC entities should formalize the wages or guaranteed payments to one member for services as part of their operating agreement.

PDtax :

http://smallbusiness.chron.com/tax-benefits-guaranteed-payments-llc-19208.html is a link to non-tax code narrative regarding the treatment of guaranteed payments from an LLC, and is correct. If you need IRC code sections for the subject, I will assemble them.

PDtax :

IRC 707 covers the subject of transactions between a partnership (your family LLC) and a partner not acting as a partner (IRC 707 (c)). That is an omnibus Code section, which then refers you to the treatment sections of the payments, notably 61(a), which is the gross income omnibus discussion. As such, 707 introduces the separate and distinct treatment of payment for services to someone not acting as a partner. Your services for management, bookkeeping, tax prep, even consulting with the tax pro who prepares the returns, all qualify as non-partner service.

PDtax :

http://www.law.cornell.edu/uscode/text/26/707 is a link to an online Code source.

Customer:

That's great thanks. One last concern, though, are you sure that all this applies if the subject of the LLC's business is the management/administration of bond/stock portfolio, rental real estate and partnership interests, and not some "active" business like, say, construction or advertising services, just for example.

PDtax :

The LLC managing real estate is the best candidate to pay you for services as a partner. As you suspect, your portfolio management may not rise to the level of investment management as a business. It could if you added those services for others, like family members, but my answer should not be extended to your investments, only the real estate LLC with you as a member of a multi-member LLC.

Customer:

I have to leave in about two minutes. I'll see your response in about an hour. Thank you.

PDtax :

I have clients whose sloe business is the active management of real estate portfolios, and those businesses are established to pay for services (moves cash and income to management, as opposed to retention for partners). Think an S corp or management LLC that pays you a wage, while the real estate LLC collects rents and contracts with your LLC for management and other services.

PDtax :

Thanks for asking at Just Answer. I'm PDtax.

PDtax
PDtax, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 4,711
Experience: 35 years tax experience, including four years at a Big 4 firm.
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PDtax, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 4,711
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