Tax Planning – Use of a Management Company

Limited Liability Companies (“LLC”) have become a common entity choice for operating restaurants.  They allow flexibility of tax allocations, unlimited ownership options and a viable alternative to a C Corporation when the restaurant is owned by a private equity firm. One of the downsides of an LLC, however, is that members who provide services for the entity during the year could be subject to self-employment taxes on 100 percent of their share of income from the entity (in contrast, S Corporation income is not subject to self-employment taxes), as compared to wage income subject to FICA, which is limited by the maximum taxable wage base  for the Social Security portion of FICA of $118,500 (for 2015).

Active members of an LLC, however, can establish a management company to reduce this tax impact. The management company is a separate S Corporation (or sometimes a C Corporation) that houses the home office activity of a restaurant company and employs the LLC members who are providing services to the business.  Typical expenses run through the management company would include home office salaries (executives and home office support), home office rent, supplies and marketing.

If you establish a separate management company that manages your operating LLC as a non-member manager, a strong argument can be made that the owners of the operating LLC who are also providing services to the business are no longer subject to self-employment taxes on their share of operating income. Instead, as employees of the management company, they are being compensated by the management company for their services and would only owe employment taxes on the actual W-2 wages paid to the owner-employee.  Because of their active involvement in the management company (defined as working more than 500 hours per year), the owners would not be considered passive investors of the operating LLC (for purposes of analyzing the active/passive rules for loss deductibility) or subject to the new Net Investment Income Tax. 

The end result of this tax planning strategy is that the combination of the LLC operating entity and the S Corporation management company looks like a typical S Corporation from a tax perspective—receiving W-2 compensation and pass-through income is not subject to self-employment taxes. However, there are two important components of the management company concept entities must keep in mind if they plan to employ this strategy: 1) All salaries paid to owners should be comparable to executives in similar positions across the industry, and 2) The fees paid from the LLC to the management company must also be reasonable. Paying unreasonably low amounts could put this beneficial structure at risk under IRS audit.

For more information about the use of a management company from a tax planning perspective, contact Jeff Tubaugh at jtubaugh@bdo.com. And be sure to keep up with the Practice's latest thoughts by following us on Twitter @BDORestaurant.

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