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Things to Work Through with Multiple Entities
By Jason Watson, CPA
Posted Tuesday, July 6, 2021
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 scenario is super common among popular groups like doctors, lawyers, accountants and financial advisors. If your tax professional or accountant says No, push a little harder. Same with your vendor (see below).
By the way, WCG is a C corporation and pays a fee for service to each of its partners’ S Corps. We know first hand 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.
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; again, just because you have a certain look to your health insurance coverage today does not mean it is cast in stone.
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 in 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; first, the people in control are the ones licensed, and second, the licensed people are the ones earning revenue 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.
We discuss this elsewhere, but 401k plans are ideally implemented at the primary entity level, and then each S Corp adopts the plan as an adopting employer. Your 401k plan administrator should be able to help.
At times with the way the tax code works, especially Section 179, it might be challenging to drive net income down to a nominal amount in the primary MMLLC entity. Don’t get hung up on this since it is uncommon; however, it might create a self-employment tax on the residual income.
In addition, Section 179 has limitations at the individual tax return level, and as such it is reported separately on the K-1 to the member or partner. There could be a situation where one member or partner’s tax benefit is not proportional to his or her share of the revenue or profits. Don’t get hung up on this either since we can probably align this correctly within the tax return; it will just take some mental gymnastics.
As an aside, Section 179 is not as popular with the current landscape of 100% bonus depreciation.
More tax returns increase tax preparation fees. If you were just a MMLLC with your partner, you had a single business entity tax return. Creating a multi-entity arrangement adds at least two more business entity tax returns (S Corp tax return), and possible more depending on how many partners or owners there are. You might also have additional payroll “systems.” One for clerical staff at the MMLLC level, and then one for each S Corp to pay out reasonable shareholder salaries to the owners.
Let’s put some math to this conundrum. A three-owner MMLLC without the “mothership” and “baby” S Corp setup, would have all-in administrative fees of about $4,500 annually, or $1,500 per person. If the mothership MMLLC baby S Corp strategy is deployed, the all-in administrative fee for each S Corp is about $3,420 annually (tax returns, payroll, consulting, planning) and the MMLLC would be about $1,200 to $1,500. This is about $4,000 per person, or a delta of $2,500 per person.
Is the $2,500 in additional fees worth it? Perhaps. It is challenging to put a value on squishy things like flexibility, office politics, enhanced individualized tax strategies, etc.
This one is goofy, and 99% of the time won’t come into play. But! If you owned a bunch of assets in your S corporation including an interest in the primary entity (the MMLLC), upon your death the S corporation would need to be valued to receive what is called a step up in basis. For example, you bought a house for $150,000. You die. The house is worth $500,000. Your heirs sell it for $500,000. There are no capital gains since the heirs receive a step-up in the basis to go from $150,000 to $500,000 upon your death.
The tricky part is valuing an S corporation since we would value the enterprise as whole. Sure, it would comprise of individual assets being assembled into an enterprise value but there could be some complication.
Another concern along these lines, which we also address in a later chapter, is the appreciation of assets. When you revoke an S corporation election or shutdown the business, the assets are distributed at fair market value. So, if your S Corp owns interests in the MMLLC, and that interest has increased in value, there could be capital gains taxes without a transaction.
We solve this concern using the previous schematic where the interests in the MMLLC are owned individually rather than through an S Corp. We only express this concern should your member interest be held within your S Corp.
Sidebar: We mentioned this in several different ways throughout this book, and we’ll say it again here. There is a strong desire to put everyone 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 your tax position and usually yet unintentionally increases risk.
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