New business - S Corp and Questions

[chuck1212]

Question 1:
I'm starting a new business. I will be the single member owner/employee of the S Corp company. My brother is funding 2/3 of the startup costs. My business will complement his business as well as being able to stand on its own. He and I have a really good trust between the two of us. Our life goals, ambitions and personality is identical. I would never lie, cheat or steal from him and vice versa.

We agreed that any net profits from this new company will be split 50/50. I understand that first I would give myself a reasonable salary for the work. Any net profits at the end of the day would be split between my brother and I. He doesn't care of want to be involved in the business other than to split the net profits. He doesn't even want to be noted anywhere in the business that he's an owner/shareholder. Yes, people would say he's stupid as I can cut him out and deny any agreements of the 50/50 split. From this perspective, I have nothing and he has everything to lose. Again, we have that kind of level of trust.

My question is how do I go about splitting the net profit with him without any unnecessary tax burden on me. What I was thinking is that whatever net profits from the company is disbursed to me, after taxes are taken from it, I would give him 50% of it when I receive it. As an example, say the company made a $1000 profit for the pay period or quarter. It's distributed to me and I pay whatever tax is levy on it. Let's say it's taxed at 20% for the sake of this example. My take home profit would be $800. Of that $800, I would give him $400.

Somewhere, I feel there are ALARMS going off but I'm not seeing them or hearing them.



Question 2:
With the S corp, how do I fund the company with my own money to make purchases for equipment and supplies and to be repaid back for them? Do I write up a loan agreement between me and the company? If so, any suggestions on what should be on the loan agreement since it's a new business and any future repayment amounts or dates are unknown.


This is all new to me and I appreciate your inputs.

Thank you!
Chuck

[vangogh]

Welcome to the forum Chuck. First, know that this stuff gets less confusing with time. Second, know I'm not an expert with this so keep that in mind as you read my response.

I have a brother who I trust the same way you and your brother trust each other. It sounds like your brother doesn't want to be involved in the business, in which case don't have him involved. Have him give you money personally, which you then invest in the business. You run your business as you only. Collect revenue, pay taxes, and do whatever you want with the money that's left over, including giving some to your brother. That said, I would think the better idea is to have him be a partner in the business if he's going o be involved in any way, but if he doesn't want to then have any money between you be personal money.

As far as making purchases, I think what you want to do is set up a business account for the business and then you can move personal money to that account. Then the business makes the purchases and you either invest in your company or loan your company money. The purchase itself should come from the company account. Pay with a check or use a credit card for the new business account. I'm not sure if there are advantages to calling it an investment over a loan or the other way around, but the idea is you shouldn't be making purchases as an individual, you want the business to make purchases. You either invest in or loan to your business and then have the business make the actual purchase.

Having said all that, you're best bet is to ask an accountant and tax attorney.

Hope something in there helps and again this will get easier. It's confusing at first, but with each tax season it gets a little easier.

[GoldenGateTradingPost]

Hi Chuck,

You might want to discuss with your brother what a reasonable salary is and how it will be determined as circumstances change. It's fantastic that you trust each other, but that doesn't mean there can't be differences of opinion, especially when money is involved. It's usually better to explicitly get that out in the air up front.

An accountant will be able to give you options to pay your brother with the most favorable tax treatment.

Until the amount you need to pay him exceeds $10K in a calendar year you can pay him as a tax free gift (you will pay taxes on the income, of course), gifts of more than $10K in a calendar year are taxable (and as with anything related to taxes, it's more complicated than that and subject to change without notice).

Best of luck to you :)

[chuck1212]

Thank you all for your inputs.

[turboguy]

I would check with an accountant but I would think you could just give him a 1099 on your distributions to him and then you are rid of the tax liability and he has a way to show it on his income taxes.

[Business Attorney]

Having said all that, you're best bet is to ask an accountant and tax attorney.

Chuck,

If your business grows to be any size at all, the only good advice is this entire thread is the one from vangogh I just quoted.

Distributing the money on the side or "gifting" money to your brother can have CATASTROPHIC tax consequences. On the one hand, the whole scheme might be deemed a second class of stock, voiding your S corp election and causing the company to be treated as a C corp, with the result that you would have to pay a corporate level tax. On the other hand, all of the income might taxable to you and then you might have to pay a gift tax on payments to your brother to the extent that the annual "gifts" exceed the annual exclusion.

If he wants to give you the funds to put into the business and not be a shareholder, what you are really talking about is a personal loan to you carrying a variable interest based on the profits of the business. It is possible that his loan would be considered true debt and that your payments to him are interest payments, but that is far from certain. You really need to get professional advice on the structure as well as professional assistance drafting the resulting documents.

As for your Question #2, yes you should document the loan to the corporation. If you want it to be treated as a loan, you do need to have it payable with reasonable interest. It doesn't necessarily have to be repaid at fixed intervals or dates, but there should be an eventual due date or it looks like it is just an equity contribution.