A simpler way to accomplish the same thing as above is to create three entities again, but the multi-member LLC is owned by you and the other guy, not the S corporations. The S Corps then issue consultation invoices to the multi-member LLC in the amount of the revenue split driving the multi-member LLC income down to zero, or some nominal amount like $500. In other words, the payments from the MMLLC to the S Corp would be recorded as Payments for Services Rendered or Outside Contractor or something similar (see dotted lines below).
Next, the K-1 to each member would show zero, or close to zero, for member income, and the invoices would be ran through the S corporations as business income. So this still accomplishes the Eat What You Kill revenue splitting and changes the color of money through distributions from the S Corp.
This would be beneficial if you didn’t have an Operating Agreement or if you are afraid that an Operating Agreement could be too restrictive from year to year. This is also super beneficial for regulated industries like financial advisors or real estate agents where entity ownership must be individuals. In some states and certain regulatory agencies, the MMLLC can be owned by S corporations provided the named principals are the licensed / regulated individuals.
You might also reduce your exposure to state nexus based on revenue or income. If the MMLLC is a California entity issuing a small K-1 to an individual running an S Corp in Illinois, you will reduce the long-reach risk of California. We are not advocating avoiding apportionment (the allocation of taxable income to other states), but at least you are more in control of what California knows and what they don’t need to know.
We do not suggest issuing 1099s in this scenario. First, a 1099 is only required to be sent to non-corporations. Even though you might have created an LLC and then later elected S Corp status, you are now considered a corporation for taxation and your vendors are not required to send you a 1099 (although many do).
Side Bar: Business tax returns such as Form 1065, 1120 and 1120S are usually prepared by tax professionals, and as such the IRS believes revenue has a much higher chance of being recorded properly, and 1099s are not necessary. It would also be ridiculous for Verizon to receive a million 1099s from its customers. Funny, Yes. But ridiculous.
Second, a 1099 has EINs and possibly SSNs. Since these dots can be connected by the IRS, the issuance of a 1099 might invite unnecessary scrutiny. The IRS agent’s question becomes “Why did you issue a 1099 to a partner rather than let the income flow through a K-1?” “To avoid taxes and headaches” is probably not going to go well.
A multi-member LLC with a zero for taxable income (or close to it) is a no harm no foul tax return. In other words, it flies well below the radar but it also above reproach. Fred, Velma and Shaggy would get two K-1s, one from the MMLC and another from their S Corp.
Here is a brief recap of three possibilities given what we’ve discussed in the previous two schematics-
Taxpayer's Comprehensive Guide to LLCs and S Corps : 2019 Edition