Randall & Wanda decide to start their own tax law practice. On March 1, 2014, they establish R&W LLC, and file elections to treat it first as a corporation, and then as an “S” corporation for tax purposes. Randall and Wanda each contribute $100 to R&W, and each receives a 50% membership interest in the entity. Randall and Wanda also become employees of R&W LLC, paying themselves a $20,000 salary each for 1,500 hours of work (by each) during 2014. R&W LLC earns $200,000 from clients and has $60,000 of other deductible expenses (such as rent), in addition to the $40,000 in salaries paid to Randall & Wanda, for 2014. Randall and Wanda each take a $50,000 distribution from R&W LLC during 2014, in addition to their $20,000 salaries.
- Describe the tax treatment of these transactions if the form of these transactions is respected for tax purposes.
- In what manner is the IRS likely to re-characterize these transactions? What would be the tax consequences of such recharacterization?
- What is the taxable year of R&W LLC?
- What other advantages might R&W take advantage of, if they are an S Corp?