Sounds like a dance move doesn’t? “Oh man, I hurt myself doing the Cali S Corp twist.” “Are you gonna need surgery?”
The problem with the previous MMLLC that issues invoices entity structure, is that this works well in most situations except California. It still works in California as a structure, but the tax expense, namely the LLC fee, makes this tough.
California’s LLCs, including SMLLCs and MMLLCs, have an LLC fee based on gross receipts. Read that again. On gross receipts. If you make a $1,000,000 and have $950,000 in expenses, you still pay a franchise tax, called an LLC fee, on the $1,000,000. The fee is “banded” as we say since it is not a straight calculation based on a percentage.
What makes matters worse is the S Corps receiving income from the MMLLC also have to pay a 1.5% franchise tax on the net income. Therefore, the same dollar might be taxed twice; once at the MMLLC level as an LLC fee, and again at the S corporation level as a franchise tax. Yuck.
What can be done? We elect the MMLC to be taxed as an S Corp.
The graphic above is eerily similar to the previous one… except S Corp replaces MMLLC. The MMLLC is now taxed as an S Corp and Fred, Velma and Shaggy remain as shareholders. After paying the other S corporations a fee for Payments for Services Rendered or Outside Contractor or something similar, the MMLLC S Corp will have very little taxable income, such as $1,000. This will be taxed by California at $800, the minimum franchise tax.
The MMLLC S Corp would not pay salaries to its shareholders since the income is so low, and there isn’t any cash available. In addition, distributions theoretically should be $0 since all the cash is leaving in the form of payments to the other S Corps. There might be some goofiness if the MMLLC has depreciating assets or loans or some other transaction which causes net income to be something other than a $1,000 and shareholder distributions to be something other than $0.
The other S Corps, owned separately by Fred, Velma and Shaggy would carry on as normal. Pay expenses related to themselves, pay salaries, provide distributions, etc. Fred, Velma and Shaggy would get two K-1s, one from the MMLC and another from their S Corp.
Taxpayer's Comprehensive Guide to LLCs and S Corps : 2019 Edition