Is a single-member limited liability company (LLC) treated as a sole proprietorship for federal tax allowed to include in compensation the compensation of the single member?
A single-member LLC treated as a sole proprietorship for federal tax purposes may include in compensation the net distributive income (NDI) assigned or disbursed to the single member that is a natural person. NDI is the net amount of income, gain, deduction or loss reportable on the sole proprietor's federal tax return, Form 1040, to the extent that it relates to the LLC. For example:
Schedule C - line 31 (net profit or loss)
Schedule E - line 26 (total real estate and royalty income or loss)
Schedule F - line 34 (net farm profit or loss)
net capital gain or loss from Form 1040 line 13
other gain and losses from Form 1040 line 14
Is the employer's share of payroll taxes included in compensation?
No, the employer's share of payroll taxes cannot be included in wages and cash compensation or benefits.
What is the net distributive income (NDI) for computing compensation? How is it computed?
Net Distributive Income or NDI, for a pass-through entity, is the net amount of income, gain, deduction or loss reportable to the owners on an IRS Form K-1 for the entity’s tax year. (Actual distribution is not required.) Guaranteed payments to partners are included when computing NDI.
To compute NDI for a partnership, from the partner’s IRS Form 1065 K-1, you
add items 1, 2, 3, 4, 5, 6a, 7, 8, 9a, 10 and 11;
subtract from that result the sum of items 12, 13 and 16 ([Code L] Total foreign taxes paid); and if the partnership took a cost of goods sold deduction for depletion in its margin calculation, then also
subtract the amount of depletion taken on the partner’s personal return.
To compute NDI for each owner that is a natural person for an S corporation, from IRS Form 1120S K-1, you
add items 1, 2, 3, 4, 5a, 6, 7, 8a, 9 and 10;
subtract from that result the sum of items 11, 12 (Codes A-G) - Contributions, and 14 ([Code L] Total foreign taxes paid); and if the S corporation took a cost of goods sold deduction for depletion in its margin calculation; then also
subtract the amount of depletion that the S corporation taken on the member’s personal return.
If net distributive income (NDI) is negative, does it have to be included in compensation?
Yes. If an entity elects to subtract compensation in computing its margin, it must include all compensation as defined in Tax Code Section 171.1013, Determination of Compensation. If NDI is a loss, then treat it as a negative number when computing the entity’s compensation deduction.
How does the wage limitation for the wages and cash compensation component apply when W-2 wages and a K-1 are issued to the same person?
If an entity issues a W-2 and a K-1 to an individual, add the individual’s W-2 and K-1 amounts together and apply the 12-month period wage limit allowed each individual when computing the entity’s compensation deduction.
If the accounting period on my report is less than 12 months, can I still deduct the full amount of the wage limitation in wages for each person?
No. If your entity’s accounting period is more or less than 12 months, you must pro-rate the wage limit over the length of the accounting period.
For example, if you are filing the 2016 report for the accounting period Jan. 1, 2015, to June 30, 2015, the deduction for wages and cash compensation is not $360,000 for a 12-month period; rather, it is limited to $180,000 for each person for the 6-month period. To calculate this pro-rated compensation deduction amount, you
add the number of payroll periods (i.e., weekly, monthly, etc.) in the accounting period;
divide the number of payroll periods in the accounting period by total payroll periods in a 12-month accounting period; then
multiply by the 12-month compensation deduction limit; and
In determining the compensation deduction for franchise tax purposes, can a partnership include the costs of tax-qualified defined contribution and defined benefit retirement plans as well as health care costs (“benefit costs”) that are deductible for federal income tax purposes on the individual partners' returns?
Yes, but you treat benefit costs differently for franchise tax based on how you report them for federal tax purposes.
When you do not deduct your benefit costs as guaranteed payments on IRS Form 1065, on Schedule K, line 13d and on Schedule K-1, line 13 – You can include your benefit costs in your compensation deduction of your partnership for franchise tax purposes without regard to the wage limitation.
When you deduct your benefit costs on IRS Form 1065 as guaranteed payments – You can include your benefit costs in your compensation deduction of your partnership for franchise tax purposes without regard to the wage limitation if and only if you adjust the amount you deduct as a guaranteed payment as may be necessary to prevent a double deduction of benefit costs.