Single Member LLC: Self Charged Interest to Reduce SE Tax?

Question

Questions:

(1) May the owner of a single member LLC loan money to the company and charge the company interest for the loan?

(2) If so, is the interest paid by the company a deductible expense to the company reported on Line 16 of Schedule C and is the interest income received by the owner taxable interest reported on Line 8(a) of Form 1040?

(3) Would the foregoing strategy effectively reduce the net income of the company and thereby reduce the self employment tax (i.e., by making the interest on the loan ordinary income to the owner)?

Background:

I recently quit my day job to focus full time on real estate investing. I am focused on infill development of newly constructed single family homes within mature suburbs in northern New Jersey. (Translation: buying 'tear downs' and building new construction in desirable neighborhoods.)

I formed a single member LLC to be taxed as a sole proprietorship. My reason for doing so was, in part, so I could hire my wife as the sole employee of the business and cover her (i.e., our family's) health insurance premiums and out-of-pocket medical expenses as a tax free employee benefit. The reimbursement of premiums and out-of-pocket expenses, under a properly formed Section 105 Plan, will be an expense to the company, thus reducing income tax and self employment tax, and will be a tax free benefit to my wife.

I am aware that I could have formed an S-corporation or an LLC to be taxed as an S-corporation, which would have allowed me to pay myself (i) reasonable wages (which would be subject to self employment tax) and (ii) an owner's distribution (which would not be subject to self employment tax).

My question is, however, having chosen to form a single member LLC, can I reduce my self employment tax by loaning money to the company (done properly and documented with a promissory note, etc.) rather than making a plain vanilla capital contribution, and charge myself a reasonable rate of interest, which would then create an interest expense for the business (reducing net income and, thereby, reducing self employment tax) and create taxable interest for the owner (subject only to income tax and not self employment tax)?

I have spent a fair amount of time on google and cannot find an answer to this question. (I know...I know...consult with my CPA...)

Patrick Liska · Answer

Having the 105 plan will reduce your SE tax, but it will be taxed as income, 105 is a reimbursement, the receiver of the reimbursement ( your wife) has to add that to their gross income, which you can deduct part of your medical expenses then. that will save you some money on taxes. loaning your own self proprietor llc money again may reduce your SE tax but on the personal side you will be taxed for the interest you pay your self on that loan. Hopefully a CPA will answer this, but that's the way i see it, you will save on your SE tax in both instances.

Michael Plaks · Answer

@Ryan H.

I like your thinking. I don't see why not, as long as the funds are used for legitimate business purposes and not commingled.

You can probably accomplish more with a husband-wife LLC, but it's a different conversation.

Single Member LLC: Self Charged Interest to Reduce SE Tax?

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