Things to Work Through with Multiple Entities

There are some things you need to work through with the multi-entity arrangement. Depending on your situation, some of these things might be show-stoppers. However, don’t take the first answer as the only answer. A multi-entity arrangement is super common among groups like doctors, lawyers, accountants and financial advisors. If your tax professional or accountant says no, push a little harder. Same with your vendors (see below).

By the way, WCG CPAs & Advisors is a C corporation and pays a fee for service to each of its partners’ S Corps. We know firsthand the ins and outs of this arrangement since we live it. Why a C Corp? We also have employees who own shares but are not partners per se. We didn’t want to complicate things with a partnership, special allocations, a second class of members, K-1s, profits interests and blah blah blah. Everyone understands corporation shares. We get into the other reasons a C Corp mothership can make sense later in this chapter.

Self-Employed Health Insurance

Check with your health insurance broker or point of contact on how the health insurance needs to be administered. Does the primary entity pay for it, with each S Corp reimbursing 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. Again, just because your health insurance coverage looks a certain way today does not mean it is cast in stone.

At times, when using a professional employer organization (PEO) to administer your payroll and benefits, you might need to process a small shareholder salary or guaranteed payment at the mothership level for each owner to allow for health insurance coverage. This in turn reduces the fee for service or management fee that is paid out (a small payout matrix might be created). Whether it is a salary or a guaranteed payment depends on whether the mothership is an S Corp or a partnership.

Sidebar: The introduction of a PEO, and the rules they operate under, can cause inefficiencies if payroll is required for each owner at the mothership, or primary entity, level since payroll is also being processed at the baby S Corp level. Unemployment and perhaps a small increase in Social Security and Medicare taxes might occur. Also, if an owner’s combined wages exceed the wage base, the owner gets the excess employee withholding back on their individual tax return, but the extra employer share is a forfeited tax, and becomes a cost.

Professional Liability Insurance

This is similar to health insurance, but ideally the policy should be maintained at the primary entity level. For example, WCG’s errors and omissions policy is held by WCG, but each partner is named as a principal of WCG and as such is covered by the single policy. This took minor coordination with our insurance provider, but since many accounting firms are set up similarly, it was easy to add language to our Bylaws and Shareholder Agreements to satisfy. You might also have to name the S Corps as additional insureds.

Licensing and Compliance

We mentioned this previously, but we want to circle back on it again. Licensing and compliance can be a bit larger of a rock going up a bit steeper of a hill. 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-

• The people in control are the ones licensed.
• The licensed people are the ones earning the revenue, or compensation of sorts, from the practice.

In other words, they don’t want some murky structure where a faceless business is practicing law or medicine, as an example, without individual licenses.

What has helped other licensed and certificated people is using the words “tax vehicle” when having this conversation. When explaining the multi-entity structure, try to focus on two things: the licensed people are still the people doing the work, and the structure is designed for tax efficiency. Luckily, you shouldn’t be the first one to introduce this concept to your governing body. Hopefully they give you the “yeah, yeah, yeah… slow down sparky… here’s what we need from you to make this work” response.

401k Plans

We discuss this elsewhere, but 401k plans are often simplest when implemented through one plan at the mothership level, with the baby S Corps participating as adopting employers. Since the entities frequently need to be tested together under the affiliated service group rules anyway, one coordinated plan can be easier to administer than several. Your 401k plan administrator should help structure this.

Depreciation and Equipment

When the mothership buys equipment or other assets, the cash spent on them cannot also go out as fees to the baby S Corps. If the deduction is spread over several years, the mothership can have taxable income without the cash to distribute. That income lands on each member’s K-1 and, for working partners in a partnership mothership, can be subject to unnecessary self-employment tax. That defeats the purpose, since the whole point of routing the money through the baby S Corps is to keep it away from self-employment tax.

With 100% bonus depreciation now permanent for qualifying property, equipment purchases often produce a matching deduction in the year of purchase. The bigger issue is cash retained for working capital, debt payments and future purchases, which doesn’t necessarily come with a deduction. Don’t get hung up on this, but understand the distinction.

In addition, Section 179 deductions are separately stated on each member’s K-1 and subject to limitations at both the partnership and partner levels. The allocation follows the partnership’s tax allocation provisions, which might not match each professional’s production formula. That can create uneven tax benefits or carryovers, so coordinate the depreciation decisions before making large purchases.

Professional Fees

More tax returns increase professional fees. If you were just an MMLLC with your partners, you had a single business entity tax return. Creating a multi-entity arrangement adds a business entity tax return for each owner’s S Corp, plus a payroll for each S Corp to pay reasonable shareholder salaries, on top of any payroll for clerical staff at the mothership level.

Let’s put some math to this conundrum. Without the construct, a three-owner MMLLC files one partnership tax return, about $1,700 to $1,800, paid by the business. With the construct, each owner adds a Vail Advisory Platform (wcginc.com/vail) at $4,920 per year, which covers the S Corp tax return, the owner’s personal tax return, the payroll plan, tax projections and strategy sessions, plus payroll processing of about $900. Since the owner’s Form 1040 moves inside Vail, the net increase is roughly $5,000 per owner, assuming the owner’s tax return was already being professionally prepared. It’s less where you already pay for projections and planning. The mothership keeps filing its own tax return as it did before.

Is the roughly $5,000 per owner worth it? Perhaps. An equalization bonus of $30,000 a year under the Social Security wage base costs about $4,600 in payroll taxes by itself, which covers most of the difference before anything else is counted. Beyond that, it is challenging to put a value on squishy things like flexibility, office politics, varying tax risk profiles and individualized tax strategies.

State and Local Taxes

Here is another wrinkle. Some states tax gross receipts rather than net business income, and your fancy multi-entity arrangement can make things worse. Washington has its Business and Occupation (B&O) tax, New Mexico has its gross receipts tax, and Oregon has its Corporate Activity Tax. New Jersey also has minimum taxes and partnership filing fees that can add up with multiple entities.

Here is the kicker. Your mothership collects $1 million from customers and pays $800,000 in fees to the baby S Corps. Depending on the state, the mothership might be taxed on the $1 million, and the baby S Corps might be taxed again on the $800,000. Same underlying economic activity, two layers of taxable receipts. Lovely!

There are deductions, exemptions and exceptions, but the lesson is simple. A multi-entity arrangement that saves federal payroll taxes while providing flexibility might increase your state and local taxes. Run the numbers before celebrating. Nice things cost money.

We specifically dig into California later. See our California Multi-Member LLC S Corp Twist section.

Asset Appreciation

This one only applies if your S Corp owns your interest in the mothership, which is the version we no longer recommend. As we covered with the fee for service arrangement, an S Corp holding an appreciating partnership interest creates gain without a sale when the S Corp is shut down, and at death the step-up in basis stops at the S Corp stock rather than reaching the interest inside it. Owning the mothership interest personally avoids both.

Sidebar: We have said this in several different ways throughout this book, and we’ll say it again here. There is a strong desire to put everything you own and do into your S corporation. Don’t! The primary purpose of an S Corp is to reduce the amount of earned income subjected to Social Security and Medicare taxes. Holding assets and investments in your S Corp rarely improves