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New LLC (local bar) with two members, no salary, but tips. How are they recorded?

We are working on a new LLC and will be owning a local bar. The two owners will be the only workers at the start (no employees) and will not be drawing a salary until profitability. How are tips handled in this situation? Are they recorded as income for the business (bar) or as individual additional income on tax records? These would include charged and cash tips.

Comments

  • NOT my area of expertise but there is no free money. Either we have a partnership for taxability purposes or we have employees. What very little I know about LLCs tell me that some sort of determination for tax reporting was made at the time the LLC was setup, and this is not a one-size-fits-all answer, but one in which you need to examine those documents and the related decisions made. Of course, I have always been a C corp kind of guy. LLC was something I took in school (back when dinosaurs roomed the Earth) and never had to do for real.

  • LLC with two members is a partnership unless an election is made to be treated as a C corporation or an election is made to be treated as an S corporation - then it is treated as a corporation for federal tax purposes. If it is a partnership for tax purposes, the members are not employees and do not draw salaries but rather the net income or loss flows through to the individual members according to the revenue or loss sharing agreement as ordinary income.
    The partnership files Form 1065 and issues K-1 Forms (sort of an expanded 1099) to the members.
    Tips are tips and if partners receive them, I believe they are essentially self-employment income. Perhaps a cleaner way to handle them is to treat them as partnership revenue. It is possible to designate them as guaranteed payments to the partners so that each partner receives the tips paid to that partner. The guaranteed payments will be subject to self-employment tax,

    If either corporation status is elected, then the members will be owner employees and should be paid a reasonable salary based on the facts and circumstances - in that case, any tips would be treated the same as for any other employee - that is, reported to the employer (the corporation) if more than $20 (as I recall) per month and taxes withheld on the tips as well as any wage or salary paid to the owner employee.

    You did not ask, but be sure to get with a tax professional right away and start tracking basis - outside basis, which is your individual investment in the business and any changes to that and, if a partnership or S Corp, inside basis which is the amount invested plus or minus any gains additional contributions, income, loss, and other adjustments internal to the organization. This can be particularly true if the members contributed non-cash resources to the partnership or S- corp. If the election is made for a C corp, you will have some sort of "shares" (stock type) arrangement to indicate ownership interest from an outside basis standpoint. Outside basis may limit losses that may be deducted from other income.

    In any case, inside basis may be different from outside basis. Outside bases determines gains and losses on disposal and inside basis determines whether there is taxable income from distributions. For partnerships and S-corps, income does not have to be distributed to be taxable.

    If you don't understand any of this, get with a qualified tax professional before you get far enough down the line that fixing this is not a major problem in the future - also the computation of inside basis is required for the pass through entity tax returns.

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