You and a few business colleagues are starting a professional services group. You like the S-corporation structure as you have heard you can save on employment taxes however ensuring you will each be able be compensated each year in accordance with your contribution to business success.
For most professional service groups (and many businesses in other industries) setting up a multi-member LLC as a holding company with each business owner having their own S-corporation as an owner under the holding company umbrella is significantly more attractive than having a single S-corporation. This is a parent-child income "flow-down" arrangement.
The reasons can be many – depending on your unique situation. So many, in fact, we will be cover many of the pitfalls is a separate article.
A holding company that is a multi-member LLC (MMLLC) with each business partner/member owning an S corporation independently is a attractive. Each S corporation is owned 100% by each principal involved. Clean.
One limitation of a single S corporation structure is that the distribution from an S-corporation must be made in the same percentage as the business ownership percentage split.
If you are 50-50 with another shareholder, distributions must also be 50-50. Do you want to lock yourself into this requirement? What if you deserve a higher distribution in one – or many – years in business?
If this multi-member LLC was not an S-corporation the Operating Agreement could dictate a different schedule of distributions. You and your partner could be 50-50 partners from an ownership perspective but have the splitting (sharing) of net ordinary business income after expenses and deductions, and eventual distributions fluctuate based on the energy and efforts of each member to the success of the business each year. Elegant.
If you instead chose to set up a single S-corporation – good luck. Regardless of your increased contribution to the businesses success or income splitting plans outlined in your Operating Agreement, any and all distributions made from the S-corporation must be 50-50 if the ownership percentage is 50-50.
Each Member / S corporation owner Controls his/her own Expenses and Decisions regarding Fringe Benefits
In the MMLLC multiple entity structure arrangement with each business partner/member owning their own S corporation, each S-corporation is independent. Beautiful.
Expenses and Fringe Benefits
You and your partner want to buy automobiles. Great! How much are we spending?
You want a small economic Sedan and your partner wants a Tesla.
You need to insure your whole family however your partner doesn’t need insurance.
You fly business class however your partner insists on flying first class.
You have significant home office expenses, and your partner does not.
You don’t want family on the payroll and your partner wants his kids on the payroll.
You travel to conferences across the U.S., and you partner only attends on-line conferences.
Each S-corporation owner can incur expenses and take on fringe benefits at their level of comfort without regard for the needs and interests of the other business partners/members and stay clear of office politics, arguments and avoid financial disputes.
Things to Work Through with Multiple Entities
Check with your health insurance broker or point of contact on how the health insurance needs to be administered. Do we have the primary entity pay for it, and each S Corp reimburses the primary entity? Can the policies be split up and paid by each S Corp separately, or does that mess up the group policy rates? These are questions that need to be explored.
Ideally the policy should be maintained at the primary entity level. For example, the MMLLC’s errors and omissions policy is held by the MMLLC, however each partner can often be named as a principal and, as such, be covered by a single policy.
Licensing and Compliance
If your trade or profession is governed by a regulatory body, you’ll need to ensure the multi-entity arrangement is in compliance. Typically governing regulatory bodies want to ensure two things; first, the people in control are the ones licensed, and second, the licensed people are the ones earning revenue from the practice.
If you and your business colleagues are setting up s company or you have an S-corporation and frequently involved in financial disputes with your partners regarding income payouts and expenses each is incurring, give us a call to discuss your options.
Cobalt PacWest | CPAs & Advisors
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