So my business partner and I have a 50/50 LLC here in Indiana. He wants to stop taking guaranteed payments and instead be paid as a 1099 contractor. He says it's better for taxes. I'm not so sure. Anyone dealt with this? What are the risks?
Taxes
My Indiana business partner wants to be paid as a contractor
That sounds like a disaster waiting to happen. If he's a partner, he can't be a 1099 contractor for the same partnership. The IRS will reclassify him and you'll owe back taxes and penalties.
Hmm. Actually, there's a nuance. If he's a member of the LLC taxed as a partnership, he's generally not an employee, but he also can't be a contractor. He's a partner. Self-employment tax applies either way. What's his actual reasoning?
Tell him to read IRS Pub 541. Partners are not employees. They can't get a W-2 or a 1099. Guaranteed payments are the correct mechanism. If he wants to be a contractor, he needs to leave the partnership.
Could he form his own single-member LLC and invoice the partnership? That's a thing, right? But then he'd still be a partner for tax purposes. I think the IRS looks through that.
lol @ 'better for taxes.' He probably thinks he can deduct more expenses. But as a partner he already can dedduct unreimbursed partnership expenses on his personal return. So what's the gain? Maybe he wants to avoid the 15.3% SE tax? Not gonna work.
I've seen this before. It usually ends with the IRS assessing employment taxes and penalties. The partnership could be liable for payroll taxes if they treat him like a contractor but he's really a partner. Also, Indiana might have its own rules. Better talk to a CPA.
Short answer: no. Long answer: nooooo. He's a partner. Partners get guarantede payments, not 1099s. If he wants to be a contractor, he needs to dissolve the partnership and contract with the new entity. But then he loses his ownership stake. Is that what he wants?
OP, what does your operating agreement say? If it's silent, you might need to amend it. But changing his status to contractor doesn't change his ownership. He's still a partner. The IRS will see through it. Don't do it.
Also, if he's a contractor, he'd have to pay both halves of self-employment tax anyway. So his tax savings are are imaginary. Unless he's committing fraud. Which I wouldn't recommend.