The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: BronzeSpoon on December 01, 2013, 03:42:07 AM
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Executive summary:
When I was a kid, my parents made me a 40% partner on paper in one of their businesses, now they expect me to pay taxes out of pocket on 40% of the earnings, though I won't see a penny in return until they die. Is this reasonable? If not, what should I do about it?
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When I was a child, the top estate tax rate in the US was 50%. Imagining half of what they'd built disappear in taxes if they didn't act, my parents made me and my siblings partners in one of their businesses and, over the space of a few years, transferred ownership to us. I currently "own" 40% of that business, or about $300,000.
Unfortunately, that 40% stake means I have to pay taxes on 40% of the profit out of pocket, from my work as a consultant. My parents take 100% of the profit and view the taxes I incur as the "price" of my inheritance. So far, it's left my husband and me on the hook for about $60,000 in extra taxes over our working lives, and my parents still have long lives ahead of them.
I don't feel that the profit from the business should be mine, as I didn't do anything to earn it, but I feel the taxes are a business expense, and so should be covered by the business. I've told my parents as much, but they're adamant this is simply the way the world works. I don't want to cause a rift in the family, but I find the situation more and more unbearable as the years drag on. I just don't see what I can do about it.
Am I unreasonable? If not, any advice?
What I've tried so far:
* Getting my siblings onside. They don't care because they don't earn much and my parents cover their taxes.
* Speaking with my parents' accountant. He finds the situation unreasonable as well, and has told my parents as much.
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Just to be clear, you don't actually receive any income from this business? If now, then yes it's screwed up, and what really seems to be happening is they are seeking financial assistance from you in some convoluted way. Why else would they "cover" your siblings who can't afford to pay and not cover you?
Maybe a different conversation needs to be had.... Are they/the business in trouble financially?
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It is screwed up. I'd "disinherit" myself from any future benefits and stop paying their taxes. Especially if you are young and have time to build your own financial security. That $60,000 you've already paid them could have grown to a significant sum of money if it had been invested for the long haul and you left it alone.
The costs attached to your future inheritance are too high, in my humble opinion.
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Tell them the way Your World works is that you will only pay taxes on earnings passed to you. Depending on how long this goes on it could be a huge money loser for you. The business could be gone in 20 years or liquidated to pay legal or medical bills. Your parents world view suggests trouble ahead. Get out!
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I see this situation often. I'm assuming this is an S-Corp, LLC, or Limited Partnership. You should tell your parents you need a distribution for taxes, somewhere between 30-40%.
What type of business is it? If this is a nice real estate partnership and your getting hard tangible assets at the end, I'd suck it up and pay the taxes. If it's not, then you may want to consider tells them that you'll pass.
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You are a passive partner or S corporation shareholder in a business that makes few or no distributions. If the books are open to you, and the business is on great financial footing, this might be a good long term investment.
If the books are not open to you, you can't tell whether you're being screwed. Get access or get out.
If the taxes for this business are more than 25% of your annual savings, you have a diversification problem. If everything else seems solid, you might consider asking for a partial buyout. Unless you're excited about operating the business if and when you inherit.
If the books are open to you, determine whether liquidation of the business could distribute the earnings you have already paid taxes on. If it could, you are making a long term investment, evaluate it accordingly. If it could not, you are giving your parents an interest free loan, and they are underwater.
The sibling issue is a question of fairness. If your parents are paying taxes on the siblings share but not yours, you could ask that the different treatment be used to increase your stake relative to your siblings. But only if this is a business that you are excited about owning and operating some day.
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To me it sounds screwed up. I'd get the advice of an attorney.
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It is screwed up. If you own 40% and are paying 40% of the taxes then you should be getting 40% of the profits each year. Since that is not happening you need to extract yourself from the situation.
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I'm thinking that if you aren't seeing any profits there might not actually be any, which is still not a profitable situation for you but is at least more defensible from your parents' standpoint. First step is get a look at the books for sure. It's just a bunch of speculation otherwise.
^it's probably clear to someone who actually knows about this stuff that I have no idea what I'm talking about.
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Also, anybody telling you
this is simply the way the world works
is just telling you the way their world works. No need for you to take part in that world if you don't want to. At the very least, I would hope that your parents support your agency to make your own decisions as an adult.
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Wow, I'd be out of that deal so fast! If it damages family relationships, so be it, they are taking advantage of you by forcing you to pay a portion of their taxes. If you were actually receiving income it would be different. Like others have said, you can save your own money and secure your own future without the dubious possibility that this business will be worth anything when they eventually pass on.
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Thanks for all of your responses.
Some answers to questions/comments in the thread:
- It's a partnership. The underlying asset is real estate.
- I have seen the books, though it was some time ago. The business seems to be doing well according to various sources.
- I don't receive any income from the business.
- The taxes paid are less than 25% of my savings.
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To make you feel better about not going along with this:
(Amount you are paying this year) * (parents life expectancy) then compound interest at 7% for that amount of time.
My guess if the number you get will be less than 40% of the value of the business. This doesn't make sense for you.
Not to MENTION that you're paying taxes with your own after-tax income.
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Is it a Limited Liability Partnership? http://legal-dictionary.thefreedictionary.com/Limited+Liability+Partnership
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When I was a child, the top estate tax rate in the US was 50%. Imagining half of what they'd built disappear in taxes if they didn't act, my parents made me and my siblings partners in one of their businesses and, over the space of a few years, transferred ownership to us.
They did this to manage the estate tax which will occur some time in the future, depending on the newer estate tax rules. A trust might have set this up better, but to be completely heartless about this, if you're a 40% owner you should be receiving 40% of the income, depreciation, etc.
If not -- I am not an attorney so this is not legal advice -- it seems to me that not only are they expecting you to pay taxes for income you're not receiving, you're on the hook for a host of legal disasters that could occur and leave you and your siblings liable.
In your shoes, as I understand the situation, I'd talk to an attorney.
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Yes, it's crazy that you're paying taxes without receiving income. It's worth asking, is this scheme even legal? Are your parents essentially robbing you of legally entitled income? You should talk to a lawyer, and if it is, you should tell your parents that you don't want to risk legal complications down the road when ownership is transferred or the properties are liquidated. If the corporation owes you tons of income, that may represent a large lien against the property and may entitle you to full ownership at the expense of your siblings. How does your parents accountant justify this arrangement? Could he be legally implicated as well? Do your parents have a lawyer that offers advice on matters related to this corporation. While you don't have to threaten anyone with legal action, asking some pointed question could turn up the heat on the various players involved, and possibly right this ship.
At the very least, if your parents are covering your siblings taxes but not yours, you should be accruing additional equity in the business to compensate. If not, you should just tell them you have other, more pressing, priorities for your money than paying these taxes. If your siblings aren't paying taxes, telling your parents to go pound salt might be awkward at first, but it's hard to imagine that something that's ultimately equitable would cause a rift in the family.
As other have wondered, is there something going on with your parents finances that they don't want to pay the taxes themselves? Are they viewing your tax payments as something of a reverse mortgage of the properties?
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Is it a Limited Liability Partnership? http://legal-dictionary.thefreedictionary.com/Limited+Liability+Partnership
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When I was a child, the top estate tax rate in the US was 50%. Imagining half of what they'd built disappear in taxes if they didn't act, my parents made me and my siblings partners in one of their businesses and, over the space of a few years, transferred ownership to us.
They did this to manage the estate tax which will occur some time in the future, depending on the newer estate tax rules. A trust might have set this up better, but to be completely heartless about this, if you're a 40% owner you should be receiving 40% of the income, depreciation, etc.
If not -- I am not an attorney so this is not legal advice -- it seems to me that not only are they expecting you to pay taxes for income you're not receiving, you're on the hook for a host of legal disasters that could occur and leave you and your siblings liable.
In your shoes, as I understand the situation, I'd talk to an attorney.
Yes, stat. Talk to an attorney, and bring all the info you've given us to him/her, plus the following:
- What's the corporate structure? S-corp, LLC, what?
- Are you named on the company's insurance policies? (You should be--adding you should cost them little or nothing--and you need it in case you're exposed to any liabilities through this company).
- Do you get a K-1 or other appropriate tax form (whichever form goes with this type of corporate structure) each year?
- Do your parents get any cash out of the business each year (do they pay themselves salaries or a share of the profits), or is everything plowed back in to the business?
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Thanks for all of your responses.
Some answers to questions/comments in the thread:
- It's a partnership. The underlying asset is real estate.
- I have seen the books. The business seems to be doing well.
- I don't receive any income from the business.
- The taxes paid are less than 25% of my savings.
I have a real estate business too. What is happening to the profits in the business? Are you sure your parents are taking it? Is it being reinvested? If so, is the real estate stable and/or appreciating? If the profits are not being reinvested, is it being held in a business account? If your parents are reinvesting all the profits on behalf of the business or adding to acquisitions, that could explain their position. However, I thought you mentioned that they are keeping all the profits. I see several people are giving you advice to get out but I don't think anyone should without additional facts. As someone who has done this for a long time, I would like to say that it depends. It depends on answers to the questions I posed and other factors. Let's assume that when your parents acquired the real estate it was worth $100K but now it's worth $2MM, then their position becomes more reasonable, after all they have to prepare for their retirement and why should they distribute the profits to children who would one day inherit such a stepped up asset?. They may also be considering passing on complete control to you and your siblings long before they die. I think you need to communicate with them to understand their motives. I don't see them managing this much after retirement. If the property has appreciated substantially, I think you'll be in a good position even if you pay the taxes. Barring any unforeseen circumstances such as a precipitous market drop which would wipe out all appreciation (highly unlikely and if that happens then we the entire world is in trouble), this can be a nice retirement and possibly lead to an early retirement for you.
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That sounds even worse than I thought. It sounds like you are in business together with your parents and siblings, which means that legally 40% of the profits after expenses should be yours. Now, there are ways of adjusting that percentage, such as paying your parents a wage as "managers", which is totally okay as long as the pay they receive is reasonable for the services rendered.
Now, what you said in the first post is that they "take all of the profits". Some of this could be structured to be management income for them (but it doesn't sound like that's what they are doing), but 40% of the rest should be yours. Since they are taking it, you are in essence *giving* them your portion of the profits each year. Holy cow is this a bad idea! Do you know anything about Gift Tax? Anything over $14,000 a year given from one person to another person per calendar year (2013 number, will adjust for inflation) is subject to gift tax, which is I think 55%.
You need accounting and legal advice, stat! This could cost you a boatload, even above the taxes you are paying that you shouldn't.
I restate what I said before, this is a bad deal, you are most likely better off to remove yourself from the situation.
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That sounds even worse than I thought. It sounds like you are in business together with your parents and siblings, which means that legally 40% of the profits after expenses should be yours. Now, there are ways of adjusting that percentage, such as paying your parents a wage as "managers", which is totally okay as long as the pay they receive is reasonable for the services rendered.
Now, what you said in the first post is that they "take all of the profits". Some of this could be structured to be management income for them (but it doesn't sound like that's what they are doing), but 40% of the rest should be yours. Since they are taking it, you are in essence *giving* them your portion of the profits each year. Holy cow is this a bad idea! Do you know anything about Gift Tax? Anything over $14,000 a year given from one person to another person per calendar year (2013 number, will adjust for inflation) is subject to gift tax, which is I think 55%.
You need accounting and legal advice, stat! This could cost you a boatload, even above the taxes you are paying that you shouldn't.
I restate what I said before, this is a bad deal, you are most likely better off to remove yourself from the situation.
Not necessarily. Depending on whether or not the parents take a salary or management fee, there may or may not be a profit. In fact, they may be taking a small salary for some reason. I can tell you that my husband does most of the maintenance on my property but I do not pay him a salary so we report greater profits than if he were paid a salary. If he were paid a salary, we would have to pay self-employment tax.
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Now, what you said in the first post is that they "take all of the profits". Some of this could be structured to be management income for them (but it doesn't sound like that's what they are doing), but 40% of the rest should be yours. Since they are taking it, you are in essence *giving* them your portion of the profits each year. Holy cow is this a bad idea!
I was trying to keep my initial post as short as possible, but you're right that some details are missing.
The partnership pays no salaries. It generates rental income. My parents scoop this up, all of it, and after they're done paying their taxes and the expenses on the partnership's assets, they use the money for their own living expenses, or to prop up some of their other businesses. I don't have a stake in those other businesses. I might inherit them in 30 years, but it's also possible that the businesses may no longer exist, or my parents might decide that I don't need the money (or that I'm ungrateful!) and pass them along to someone else.
Do you know anything about Gift Tax? Anything over $14,000 a year given from one person to another person per calendar year (2013 number, will adjust for inflation) is subject to gift tax, which is I think 55%.
Yep, I know about the gift tax, but I don't think they pay it on the "transfer" of cash from me to them. I'm not sure how they do it exactly.
What's brought this to a head is that my parents are currently looking to buy a house for my ne'er-do-well brother, who will "pay them rent", though he's currently unemployed and already spending his inheritance. My parents want the partnership to buy the house.
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Without having read the whole thread -- I really do have to go clean the kitchen, and I'm procrastinating -- I say maybe. I paid taxes for years on an asset that belonged to an elderly relative. It was a financial difficulty for her, and I didn't want to see the asset sold. Yes, she could've really screwed me over, but I trusted that she wouldn't. She didn't, and now it is mine. It was a worthwhile investment.
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My parents want the partnership to buy the house.
Even more reason for you to bow out, you'll be in effect giving money to your brother to have a house.
I have a brother that is trouble, so I know how tough it can be to not help out. I do help on little things, especially making sure the kids are clothed and have good car seats, but this just...yikes!
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As I understand it, what your parents are doing is crazy. And based on the fact that they are operating their business in a crazy way, I would expect them to react in a crazy way to your concerns. Good luck, but I wouldn't expect a rationale response when you point out that your parents are effectively taking your money by insisting you pay taxes on profits you do not receive and for which you are entitled.
One thought: it makes a difference if the accountant is the partnership's accountant or your parents' accountant. Assuming he is the partnership's accountant, then he owes the partnership a fiduciary duty, and not you or your parents. As a minority shareholder of the partnership (although it sounds like your 40% may be the largest share--or perhaps co-equal with your brother's), that accountant should be forthcoming with you.
It would depend on the operating agreement (which you should get immediately, I would assume the accountant would have a copy and would be required to make it available to you), but it seems that your parents are wasting corporate assets (buying a rental for your deadbeat brother), and breaching their duty to you as the minority shareholder (paying themselves profits but not you).
You would likely have legal remedies in this situation. However, to preserve the family you may not want to exercise them. I would consult a lawyer stat. You probably want to get out of this business, if for no other reason than you're a partner with people who are acting crazy by "real world" standards.
Also, some kinds of sham transactions to avoid tax consequences can expose you to liability. Talk to a lawyer. Get all the docs you can ready. Most lawyers will do a free consult.
Good luck.
Also a disclaimer: please don't rely on "legal advice" from the internet forums like this one--do your own work, hire your own attorney. :)
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Thanks for all of your responses.
Some answers to questions/comments in the thread:
- It's a partnership. The underlying asset is real estate.
- I have seen the books. The business seems to be doing well.
- I don't receive any income from the business.
- The taxes paid are less than 25% of my savings.
I have a real estate business too. What is happening to the profits in the business? Are you sure your parents are taking it? Is it being reinvested? If so, is the real estate stable and/or appreciating? If the profits are not being reinvested, is it being held in a business account?
The underlying assets appear stable. They did put in a lot of work initially to restore them. They're beautiful, actually. I'm really proud of what they did.
The money is being used for whatever they need at the time. Sometimes it's reinvested in other businesses. (I don't have any stake in those businesses. I may inherit part of them. I may not. There are several others in line, who would need it more.) Sometimes, it's used for their own living expenses. There's apparently very little cash held in a business account. I apologize for not being able to answer your questions with ballpark numbers, but my only reliable source of information is my parents' accountant, and when I talk to him, he tells my parents, which makes the relationship tense.
What pushed me to write this post is that they're currently on an urgent search for a house to buy for a chronically unemployed, lazy sibling, who will "rent" from them. They intend to use the partnership to buy the house. If my balance sheet weren't linked to theirs, I wouldn't have a problem with it. They earned the money; if they want to house my deadbeat brother, that's their business. But given that the partnership affects me directly, I feel I have some say in the matter, and this project seems like a loser.
I don't want a cut of the profits. I just want to come out whole at the end of the day.
They may also be considering passing on complete control to you and your siblings long before they die. I think you need to communicate with them to understand their motives.
They say they'll never retire. I believe them. It's in their blood.
Barring any unforeseen circumstances such as a precipitous market drop which would wipe out all appreciation (highly unlikely and if that happens then we the entire world is in trouble), this can be a nice retirement and possibly lead to an early retirement for you.
My husband and I are hoping to extreme-early retire next year (on assets we built ourselves, I should add, given the context of this discussion), but extra income on paper makes this more difficult.
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Also a disclaimer: please don't rely on "legal advice" from the internet forums like this one--do your own work, hire your own attorney. :)
Ha, ha. Don't worry. I just wanted to get some other opinions on the situation. Thanks for looking out for me, though. ;)
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Yes, stat. Talk to an attorney, and bring all the info you've given us to him/her, plus the following:
- What's the corporate structure? S-corp, LLC, what?
- Are you named on the company's insurance policies? (You should be--adding you should cost them little or nothing--and you need it in case you're exposed to any liabilities through this company).
- Do you get a K-1 or other appropriate tax form (whichever form goes with this type of corporate structure) each year?
- Do your parents get any cash out of the business each year (do they pay themselves salaries or a share of the profits), or is everything plowed back in to the business?
Those are all good questions and I should know the answer to them. Unfortunately, I don't have any answers aside from what's already in the thread. I need to get busy finding out.
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Also, some kinds of sham transactions to avoid tax consequences can expose you to liability.
I don't think they'd do anything illegal. They don't strike me as the type. They've worked long and hard to get where they are; they wouldn't jeopardize everything to avoid a few $1000 in taxes.
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This is absolutely insane.
You should be getting your portion of profits, otherwise tell them to buy your share back for at least the amount you've paid out in taxes.
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I don't think they'd do anything illegal.
Maybe not on purpose...
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I'm going to cut through it all...
You're a 40% owner and that comes with financial responsibility, it should also come with full access to information and some decision making ability.
I think it's pretty clear, you're fine paying the taxes if you have access to the books and some decision making. Using a entity you own 40% of to support your brother isn't cool and you have every right to relinquish your shares (and your parents will flip when you tell them because I'm sure it messes with their plans/control)
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I dont think it has been mentioned but do you intend to retire in the same area the property is? Perhaps, after talking to a lawyer..., you could live in one of the properties at reduced 'rent' in exchange for having payed the taxes and/or continuing to pay them.
I agree, it does not sound like you are dealing with fully rational people and maybe an unconventional or innovative solution will be needed.
Do your parents need the financial help that they are taking out of the company? I dont get the impression they have trouble buying food and paying the power bill. Legally I am not sure that matters but could they be taking that money from the company to save face from asking you?
Could you buy out the company and hire your folks to run it, doing it all above board? Give your brother a house for his shares then run it properly while retired.
The story does not make you seem at all ungrateful or entitled, if you had had to pay the taxes (uncompensated) once or twice after extraordinary circumstances I would say suck it up-look long term-help the family but not with this situation where this has been and will continue to be normal for you to pay out of pocket.
Just thinking out loud here.
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I dont think it has been mentioned but do you intend to retire in the same area the property is?
It's a possibility. It's a cheap, livable city, and despite everything, we'd like to retire close to family.
Do your parents need the financial help that they are taking out of the company? I dont get the impression they have trouble buying food and paying the power bill. Legally I am not sure that matters but could they be taking that money from the company to save face from asking you?
They do partly rely on the money for living expenses, but it's not to save face. They built up that assets underlying the partnership themselves, so they rightly feel entitled to the cash it generates. My only problem is that it's generating paper income for me, but no distributions to cover the tax hit.
Could you buy out the company and hire your folks to run it, doing it all above board? Give your brother a house for his shares then run it properly while retired.
That's an interesting possibility that I hadn't considered. It's something to think about. Thanks.
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you have every right to relinquish your shares (and your parents will flip when you tell them because I'm sure it messes with their plans/control)
This is what I've started calling "the nuclear option" with my husband. Things would have to get pretty bad for us to take that route, though. I'm sure it'd be years before they spoke to me again.
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Without having read the whole thread -- I really do have to go clean the kitchen, and I'm procrastinating -- I say maybe. I paid taxes for years on an asset that belonged to an elderly relative. It was a financial difficulty for her, and I didn't want to see the asset sold. Yes, she could've really screwed me over, but I trusted that she wouldn't. She didn't, and now it is mine. It was a worthwhile investment.
Thanks for that reminder. At the end of the day, I own a substantial asset that I didn't do anything to earn aside from paying the taxes on it for a few decades. In my case, I'm legally one of the owners of the property, so it sounds like I have a lot more assurances about coming out ahead one day than you did. I'm glad everything worked out for you.
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My parents want the partnership to buy the house.
Even more reason for you to bow out, you'll be in effect giving money to your brother to have a house.
I have a brother that is trouble, so I know how tough it can be to not help out. I do help on little things, especially making sure the kids are clothed and have good car seats, but this just...yikes!
I know what you mean. At least my brother doesn't have kids.
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OY! Money mixed with family. Lots of good varied viewpoints here. I have nothing to add except for my sympathy.
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- Get an attorney stat.
- Hire an accountant to audit the books of the LLC.
These shenanigans are exactly the kind of thing that goes on in my own family and people just don't do the prudent thing and dig into the books (and operating agreement). If you have a 40% share, then you are entitled to 40% of the profits, especially if your parents require you to pay 40% of the taxes.
If my sister was a ne'er-do-well and my parents wanted to buy her a house with my money, I would be raising hell with a lawyer and accountant on my side and not just asking Internet Mustachians for advice. We agreed a long time ago that if one of us was a huge financial burden on the other, it would be legitimate to cut off support and/or contact. This was due to seeing what went on in our family.
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No new thoughts, just adding my voice to the general view that this situation sounds quite "unusual". And +1 to getting legal and accounting advice.
The fact that you say relinquishing your share will unloose "nuclear war", again confirms that they are, at the very least, putting some unusual expectations and controls on you. Alarm bells going off.
Personally I think I would be trying to get out, preferably without upsetting them if this is possible. I would be getting out because I am quite capable of making my own FI and not being beholden to an inheritance that may or may not eventuate. And due to the illogical way things are proceeding I hazard there will be more grief entangled than disentangled.
But as others have said I am just some random on the internet... you know what is best for your situation - make sure you get the best expert advice before making any decisions.
PS would love to hear about what you decide /any update
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I'll just answer the question in the subject: Yes, this is screwed up. As in, majorly screwed up. They took an amateurish approach to minimize estate taxes and in the process thought it was ok to violate so many boundaries that they probably have put their estate at risk anyway through the amount of bad feelings, and poor succession planning with your siblings.
Not a tax expert but I'll point out that if this is an LLC or S chapter corp, the tax liability is passed through to the owners personal tax return. Tax liability therefore is only on those who get a share of the net income. (Or salary from the business). Do you have an partnership agreement? If not, the default partnership agreement for your state will apply.
Legal and accounting advice is a must. That's the easy part. The hard part is going to be facing them down when you do the right thing, and withstanding the emotional blackmail it sounds like they are ready to use on you. So, I'll suggest a good therapist too.
Good luck and let us know what happens.
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This is messed up and you're likely getting screwed. You need the counsel of a good lawyer (who is familiar with buisness agreements and corporate stuff) soon. Maybe a CPA too, to audit the books.
1. A typical arrangement in pass-through tax entities (LLCs, LLPs, S-Corps) is a clause in a shareholder/operating agreement that mandates that a percentage of profits equal to the underlying tax burdens of the owners generated by the entity be distributed each year (often, the tax burdens of the largest shareholder, or the shareholder with the largest total income, who would typically be taxed at the highest rate). This is essential to protect owners like yourself who generate "phantom" or "paper" K-1 income that generates a tax bill. You need this.
2. Moreover, partnership and other pass through entities generally require pro-rata distribution of profits. Sure, there can be management fees / salaries paid to owners who are also actively operating the business, but (a) these need to be equivalent to what a non-owner employee would be paid, and (b) approved by the owners/directors, per the shareholder agreement (which hopefully exists!). Then, whatever is considered partnership/LLC "profits" at the end of the year needs to be either distributed pro rata or retained in the owners' captial accounts.
3. You have a right, as an owner, to review the books and records of the company.
4. A good lawyer will give you the advice discretely, and set out a plan for you to broach all of these topics in a non-confrontational manner. This does not have to be contentious, although it may well become that way. Look for an attorney with whom you have a good rapport, who is sensible and not spoiling for a fight. It may ultimately come to a dispute, but you need to have a plan in place that will explore all alternatives before that happens.
Disclaimer: I'm not your lawyer or your CPA (I don't even know you), but this is common, standard advice. Retain someone soon.
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You should be getting your portion of profits, otherwise tell them to buy your share back for at least the amount you've paid out in taxes.
I like the idea of them buying you out for the amount you have paid in taxes. It might cause some dust-up in the beginning, but in the long run, I think your relationships will be healthier without these entanglements.
The way things are now, you feel ripped off because they are taking money from you but giving to your siblings. They are entitled to do as they see fit with their money, but it's not appropriate to expect you to pay for your siblings.
It doesn't sound like your parents would really be in dire straights if you declined to pay the taxes. And it sounds like this is not really that marvelous an investment for you; the money you have paid in taxes, if invested in your own rental properties, would probably be returning you as much or more than you will inherit from them at some unspecified future point.
I agree with everyone else on getting your own legal and tax opinions; perhaps you will find a legal "reason" why you must back out of the company, which could help everybody save face.
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I am a CPA and while my specialty isn't small business/enterprise type work I've seen similar situations to this in family owned/operated businesses a few times. I haven't read all replies and this may have been mentioned already, but your parents are simply using you to financially subsidize their lives/other business ventures through your cash injection via tax payment. I'd love it if someone else paid my income taxes as well, my income would go up by 30%+
Yes there are inherent issues in the way business is conducted now (surprised a tax audit hasn’t exposed that). Again without knowing the arrangement and your relationship with your parents it's tough to say what you should/shouldn't be doing as this is more of a family dilemma than a business one.
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Forgot to add, it's common to assign shares/pay dividend income to family members for income splitting purposes, but I've never seen one where the main stakeholders (your parents) are leaving you on the hook for taxes for something that you have zero involvement in, hence why I am thinking they are using you as a subsidy more than anything, which would lead me to also believe the business is not cash flow positive/leveraged/not enough working capital/could be a number of things.
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Also, some kinds of sham transactions to avoid tax consequences can expose you to liability.
I don't think they'd do anything illegal. They don't strike me as the type. They've worked long and hard to get where they are; they wouldn't jeopardize everything to avoid a few $1000 in taxes.
I'm not sure what they're already doing is legal. The entire point of a partnership is that all partners share in the expenses AND the profits. That show it works--whether it's a multi-member LLC (which can be taxed like a partnership) or just a partnership. Same goes if it's an S corp; I highly doubt that it's proper to make disbursements of S-corp funds to some shareholders but not others, assuming everyone has the same class of shares. I mean, think about it:
If they make $100k in profit each year, and on paper $40k of that is yours so you get charged taxes on it, but in fact the entire $100k goes to them, guess who's NOT telling the IRS the truth about how high their income is? Yup: your parents! Think that's legal? I'd be surprised.
If they want to handle the money differently, they should probably be paying themselves salaries that eat up most or all of the profits--if they did that, it wouldn't change THEIR cash flow or their TRUE, LEGAL tax liability one iota but it would relieve YOU of any tax burden since there would be no profits to owe taxes on. That's the legal, fair and square way to do what they're doing.... probably...I keep saying probably because I don't know what state they and their business entity are in or what type of entity it is.
You really need to talk to a lawyer, preferably one in the state where the business entity is, and one who is familiar with both corporate and tax law (corporate is shorthand for business entities of whatever type).
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I am thinking they are using you as a subsidy more than anything, which would lead me to also believe the business is not cash flow positive/leveraged/not enough working capital/could be a number of things.
It's a total head scratcher as to how they justify this to themselves. Last I checked, most people don't buy their inheritance via installment plan. If you're going to pay for something, it might as well be assets you own outright and control, not assets that you may or may not receive at some indeterminate point in the future.
It's a shame you didn't take a stand from the get-go. No one likes to get off the gravy train once they're on it. However, given that this isn't something you signed up for, I can't imagine that opting out would create a huge rift (maybe one awkward Christmas); that is, if you're parents truly don't have liquidity problems. I guess you're in a better position to judge.
Given that the original purpose of this scheme has been obviated by change in tax law, is there any chance that everyone sells ownership back to your parents for $1? This would be the simplest and most equitable solution, though there would still be the outstanding matter of your paid-in taxes.
Maybe a hostile takeover? I bet your brother would be amenable to a $100k bid for 11% of the business :)
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Mixing family/friends and business is always fraught. The reason is that that there are different norms of behavior in financial relationships and social relationships. When social norms of behavior are used to leverage financial advantage we feel very uncomfortable and rightly so. Moreover creating financial relationships where there was a social one can undermine the goodwill and even destroy the social relationship. Its very hard to get that back.
A lot of the replies in this thread are from the perspective of the financial relationship. I wonder if you need to decide what is more important - your relationship with your parents or the potential financial advantage. It is clear the current situation is putting your relationship with them under strain. Perhaps a calm, heart to heart discussion with them is in order. You could point out the angst you are feeling and suggest that you move out of the business in order to maintain your family relationships. You may have to be gently persistent about this over a period of time.
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Maybe a hostile takeover? I bet your brother would be amenable to a $100k bid for 11% of the business :)
Yes. I think many here are to willing to suggest walking away from probably several hundred thousand dollars. To bad family politics might make this a non-starter. And having your folks work for you might also not be so great.
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As above, have you considered buying your siblings shares so you can get majority ownership ASAP?
Alternatively, have you considered selling your 40% stake to an external property investor?
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I wonder if you need to decide what is more important - your relationship with your parents or the potential financial advantage.
You also have to factor in the impact that this is having on HER family aka her husband and future children. If you are a little angsty about your parents using your success to help themselves and now your chronically-needing-rescue brother, I imagine your husband is less than thrilled with the arrangement.
When parents pass away and kids grow up and leave the nest, the spouse is the one you are left with. Make sure to support that relationship as well.
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As above, have you considered buying your siblings shares so you can get majority ownership ASAP?
Alternatively, have you considered selling your 40% stake to an external property investor?
My hostile takeover suggestion was largely tongue-in-cheek, but it does highlight the absurdity of the situation. Heck, if you really wanted to play hardball you could have your attorney demand 15 years of back income x 40%.
My biggest worry is that as the years roll by, this corporation starts getting raided like a piggy bank; properties are mortgaged or sold, necessary renovations aren't done, questionable accounting and business decisions are made. It's possible that by the time you inherit it, it's negative cash-flow and much more of a liability than an asset. Purchasing a house for your brother is a warning sign, not to mention that as the corporation's assets become more entangled with your family's, exiting in an orderly way becomes more complicated. That's why I think you need to either exit your ownership position (and hope your parents treat you equitably when they pass) or partake equally in the benefits. Right now, you're getting the worst of both worlds and there's a substantial risk that things get worse, more complicated, and less cordial later.
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It sounds to me like a strange set up having to pay taxes when there are apparently profits that create the taxes and could therefore pay the taxes. However, I think a lot of people responded by saying that the OP has a right to 40% of the profits because they own 40% of the company. I disagree. The parents set up the company this way to avoid inheritance tax (presumably), so the "ownership" is really just a construct to enable things to be advantageous to the family (vs. the IRS) in the future. To then turn around and say that the OP should claim 40% of the profits seems misdirected to me. It's like putting a car in your wife's name (for whatever reason) and then she won't let you drive it.
On all the rest (getting a lawyer/accountant involved, talking to the parents, possibly giving up ownership) I agree.
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It sounds to me like a strange set up having to pay taxes when there are apparently profits that create the taxes and could therefore pay the taxes. However, I think a lot of people responded by saying that the OP has a right to 40% of the profits because they own 40% of the company. I disagree. The parents set up the company this way to avoid inheritance tax (presumably), so the "ownership" is really just a construct to enable things to be advantageous to the family (vs. the IRS) in the future. To then turn around and say that the OP should claim 40% of the profits seems misdirected to me. It's like putting a car in your wife's name (for whatever reason) and then she won't let you drive it.
On all the rest (getting a lawyer/accountant involved, talking to the parents, possibly giving up ownership) I agree.
The problem is that if OP is paying tax on 40% of the profit, but the parents are actually getting that profit, the OP's parents are engaged in tax fraud. I'm not saying the OP has an entitlement to 40% of the profits, but the problem is that this arrangement is a crime. The only way this would be legal would be if the parents did not take any distributions for themselves either, and just left all the profits in the company (possibly using them to keep buying real estate). If the parents are taking distributions and then saying those distributions went to the OP, that is criminal tax fraud and they can go to jail.
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It sounds to me like a strange set up having to pay taxes when there are apparently profits that create the taxes and could therefore pay the taxes. However, I think a lot of people responded by saying that the OP has a right to 40% of the profits because they own 40% of the company. I disagree. The parents set up the company this way to avoid inheritance tax (presumably), so the "ownership" is really just a construct to enable things to be advantageous to the family (vs. the IRS) in the future. To then turn around and say that the OP should claim 40% of the profits seems misdirected to me. It's like putting a car in your wife's name (for whatever reason) and then she won't let you drive it.
On all the rest (getting a lawyer/accountant involved, talking to the parents, possibly giving up ownership) I agree.
The problem is that if OP is paying tax on 40% of the profit, but the parents are actually getting that profit, the OP's parents are engaged in tax fraud. I'm not saying the OP has an entitlement to 40% of the profits, but the problem is that this arrangement is a crime. The only way this would be legal would be if the parents did not take any distributions for themselves either, and just left all the profits in the company (possibly using them to keep buying real estate). If the parents are taking distributions and then saying those distributions went to the OP, that is criminal tax fraud and they can go to jail.
I don't really understand how it's a criminal offense if both parties have agreed to it and the taxes are getting paid...
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I don't really understand how it's a criminal offense if both parties have agreed to it and the taxes are getting paid...
Agreement has nothing to do with it. It is a crime to falsely report on any tax return. If the corp is falsely reporting income accruing to the OP, that is a crime. Beyond that, taxes are paid at the marginal rate. If the parents are in a higher bracket than the OP, then they are avoiding paying the proper amount of tax on their income from the corporation.
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Agreement has nothing to do with it. It is a crime to falsely report on any tax return. If the corp is falsely reporting income accruing to the OP, that is a crime. Beyond that, taxes are paid at the marginal rate. If the parents are in a higher bracket than the OP, then they are avoiding paying the proper amount of tax on their income from the corporation.
Completely agree with the fact that it could be illegal. Also that paying taxes now for a possible future inheritance is risky even if it is your parents. Just wanted to mention that OP demanding 40% of the profits seemed to be a bit far in the other direction. If a talk with the parents can't get an easy solution that OP is comfortable with, I would definitely suggest getting out (in a friendly way) and dealing with the relationship fallout as it comes. Just think provoking negative reactions is not helpful.
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It might also be worth talking to an expert in trust and estates to see what they recommend. I'm sure there's a better way to structure this so that everyone's goals are met. Unfortunately, since you're paying 40% of your parents taxes, they might be resistant to any change.
I'd just take a stand. Explain that you need to focus on saving for your own retirement, and that while you appreciate the gesture of handing over ownership, paying taxes on a corporation you don't control or currently benefit from isn't a financial priority.
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Agreement has nothing to do with it. It is a crime to falsely report on any tax return. If the corp is falsely reporting income accruing to the OP, that is a crime. Beyond that, taxes are paid at the marginal rate. If the parents are in a higher bracket than the OP, then they are avoiding paying the proper amount of tax on their income from the corporation.
Completely agree with the fact that it could be illegal. Also that paying taxes now for a possible future inheritance is risky even if it is your parents. Just wanted to mention that OP demanding 40% of the profits seemed to be a bit far in the other direction. If a talk with the parents can't get an easy solution that OP is comfortable with, I would definitely suggest getting out (in a friendly way) and dealing with the relationship fallout as it comes. Just think provoking negative reactions is not helpful.
I wish there were a "like" button. In lieu of that, I have to reply to say I agree with the above completely and that was the basis of my suggestion to speak with a tax attorney: you may be an unintentional accessory to tax fraud and the IRS are not likely to be very understanding.
I agree with that entirely. I said in my original post that the OP isn't entitled to the 40%, but this corp is probably unnecessary to estate planning as was mentioned upthread, and can likely make everyone's lives easier if it is dissolved in a way that keeps people happy. And #1 on my list would be keeping the IRS happy. Also, the entire thing seems to have been founded on a sham transaction to evade (now unnecessarily) estate taxes, which is always a poor foundation for a business venture. Then again, don't take legal advice from some dude on a forum. Get real counsel from a tax attorney.
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I'm puzzled why some posters think that the OP doesn't have a right to or shouldn't push so hard as to ask for 40% of the profits. That's what partnership, or percentages of ownership, means: if you own X%, then you get X% of the profits--that's why you get taxed on X% of the profits. The OP has a legal right to a percentage of the profits equal to his percentage of ownership.
If the parents intended to keep most/all of the incoming cash for themselves since they're doing most/all of the work running the business, which is totally understandable and fair, then they need to have the business hire them and pay them salaries. If they pay themselves salaries that eat up all the profits, then there won't be any profits for the OP to owe taxes on.
The only reason I can think of for them not to have done this is because they don't want to pay all the taxes that they owe. In other words, if they paid themselves salaries, they'd have to report those salaries to the IRS and pay taxes on the entire salaries. The way they've set things up, they're getting the OP to pay their taxes for them--and probably at a lower bracket than they'd have to pay themselves (since admitting to the IRS that they're actually getting the 40% on top of the 60% would put them in a higher tax bracket than they're at now).
OP, you need to talk to a lawyer and find out not only what your rights are here, but whether you, by going along with this, are liable for anything along the lines of conspiracy to commit tax fraud. If you are it might actually make things very simple when it comes to dealing with your parents: you could say, "Hey, my tax guy noticed that I wasn't actually getting that 40% that I'm paying taxes on, and suggested I see a lawyer about that, and the lawyer said it's not kosher and has to stop. Here's what he said you could do: either actually pay me the 40%, or pay yourselves salaries that eat up the profits..."
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I'm puzzled why some posters think that the OP doesn't have a right to or shouldn't push so hard as to ask for 40% of the profits. That's what partnership, or percentages of ownership, means: if you own X%, then you get X% of the profits--that's why you get taxed on X% of the profits. The OP has a legal right to a percentage of the profits equal to his percentage of ownership.
If the parents intended to keep most/all of the incoming cash for themselves since they're doing most/all of the work running the business, which is totally understandable and fair, then they need to have the business hire them and pay them salaries. If they pay themselves salaries that eat up all the profits, then there won't be any profits for the OP to owe taxes on.
The only reason I can think of for them not to have done this is because they don't want to pay all the taxes that they owe. In other words, if they paid themselves salaries, they'd have to report those salaries to the IRS and pay taxes on the entire salaries. The way they've set things up, they're getting the OP to pay their taxes for them--and probably at a lower bracket than they'd have to pay themselves (since admitting to the IRS that they're actually getting the 40% on top of the 60% would put them in a higher tax bracket than they're at now).
OP, you need to talk to a lawyer and find out not only what your rights are here, but whether you, by going along with this, are liable for anything along the lines of conspiracy to commit tax fraud. If you are it might actually make things very simple when it comes to dealing with your parents: you could say, "Hey, my tax guy noticed that I wasn't actually getting that 40% that I'm paying taxes on, and suggested I see a lawyer about that, and the lawyer said it's not kosher and has to stop. Here's what he said you could do: either actually pay me the 40%, or pay yourselves salaries that eat up the profits..."
Yeah, I started to comment but then deleted everything. This is a legal and social mess. Best to get a firm legal grasp on everything and then consider how the different options impact your family relationship.
I'm most worried about potential liability for things the "partnership" may have done without your knowledge.
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I'm most worried about potential liability for things the "partnership" may have done without your knowledge.
Yes. And that could include tax fraud, since it's not just the parents who are underreporting their income (and the OP who's going along with this), it's probably also the partnership that's filing false informational tax returns (whether this is a partnership, an LLC or an S-corp, it must be filing returns that say it paid 40% of the profits to the OP--when in fact it didn't).
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Sounds like tax fraud, and maybe embezzlement (what else do you call using company funds on family affairs? I assume that's the name for it, though I'm not well versed in law.)
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I'm afraid this thread may have gone way off track.
I work in a line of work that sees tax returns on closely held businesses all the time. Its not uncommon to see the 2nd generation be given a non-controlling interest while the first generation does what they want with the money.
It is very uncommon to not at least distribute 40% of the taxable income to help the 2nd generation with the tax liability. All the problems stem from this issue (because the 2nd generation is effectively contributing capital when you balance the equity accounts)
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I'm afraid this thread may have gone way off track.
I work in a line of work that sees tax returns on closely held businesses all the time. Its not uncommon to see the 2nd generation be given a non-controlling interest while the first generation does what they want with the money.
It is very uncommon to not at least distribute 40% of the taxable income to help the 2nd generation with the tax liability. All the problems stem from this issue (because the 2nd generation is effectively contributing capital when you balance the equity accounts)
Exactly. To be clear, I totally agree that there's nothing wrong with giving minority shareholders a noncontrolling interest and not paying them the percentage of the profits equal to their percentage of ownership--IF you either keep the money in the company (use it to buy more real estate, just let it accumulate, etc.), or pay everyone enough to cover their tax liability, or pay the people who are actually running the business salaries (which would reduce and could eliminate the profits on which everyone's tax liability is calculated). What's incredibly strange and possibly illegal about the OP's situation is that the majority shareholders (parents) are NOT paying the second generation anything and are telling the IRS that they're only paying themselves 60% (i.e., they're skimming off 100% of the profits into their own pockets but probably only being taxed on their 60%, instead of paying themselves salaries consisting of 100% of profits and being taxed on the full 100%).
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I'm afraid this thread may have gone way off track.
I work in a line of work that sees tax returns on closely held businesses all the time. Its not uncommon to see the 2nd generation be given a non-controlling interest while the first generation does what they want with the money.
It is very uncommon to not at least distribute 40% of the taxable income to help the 2nd generation with the tax liability. All the problems stem from this issue (because the 2nd generation is effectively contributing capital when you balance the equity accounts)
Exactly. To be clear, I totally agree that there's nothing wrong with giving minority shareholders a noncontrolling interest and not paying them the percentage of the profits equal to their percentage of ownership--IF you either keep the money in the company (use it to buy more real estate, just let it accumulate, etc.), or pay everyone enough to cover their tax liability, or pay the people who are actually running the business salaries (which would reduce and could eliminate the profits on which everyone's tax liability is calculated). What's incredibly strange and possibly illegal about the OP's situation is that the majority shareholders (parents) are NOT paying the second generation anything and are telling the IRS that they're only paying themselves 60% (i.e., they're skimming off 100% of the profits into their own pockets but probably only being taxed on their 60%, instead of paying themselves salaries consisting of 100% of profits and being taxed on the full 100%).
The rule, if I'm not mistaken (For S-corps and LLC filing S which this sounds like), is that you can choose not to distribute the corporate earnings, but if you distribute earnings, they must be distributed to all owners proportional to ownership. The parents appear to be committing two frauds here. 1 is that they are filing a false return stating that the OP is receiving a distribution when the OP is not, and the other is that they are fraudulently withholding the OP's distribution and spending it themselves.
All of this is stemming from a fraudulent sham transaction to evade estate taxes, which made the OP owner of 40% of something without paying close to fair market value.
$120,000 is enough money to where a sit down with a tax attorney is well worth it. Especially if it looks like the money is about to go down the drain to help the other brother.
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It is not illegal for OP to pay someone else's tax bill, coz it's paid with after-tax money & OP didn't deduct it from her own taxes, and of course if mutually consented on, i.e. a gift. Just as you can pay someone else's mortgage or tuition, medical or property tax bill. If the parents reported the correct income and filed the correct amount of taxes, the IRS doesn't care who's bank acct the payment comes from. This appears to be a separate issue.
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It is not illegal for OP to pay someone else's tax bill, coz it's paid with after-tax money & OP didn't deduct it from her own taxes, and of course if mutually consented on, i.e. a gift. Just as you can pay someone else's mortgage or tuition, medical or property tax bill. If the parents reported the correct income and filed the correct amount of taxes, the IRS doesn't care who's bank acct the payment comes from. This appears to be a separate issue.
You are absolutely right. Your comment is one of the few rational ones I've seen. So many people are jumping to conclusion and getting excited over this being illegal. It's so interesting reading comments from people who clearly don't know what they're talking about. At the very worst, this is a gift tax issue.
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I'm afraid this thread may have gone way off track.
I work in a line of work that sees tax returns on closely held businesses all the time. Its not uncommon to see the 2nd generation be given a non-controlling interest while the first generation does what they want with the money.
It is very uncommon to not at least distribute 40% of the taxable income to help the 2nd generation with the tax liability. All the problems stem from this issue (because the 2nd generation is effectively contributing capital when you balance the equity accounts)
Exactly. To be clear, I totally agree that there's nothing wrong with giving minority shareholders a noncontrolling interest and not paying them the percentage of the profits equal to their percentage of ownership--IF you either keep the money in the company (use it to buy more real estate, just let it accumulate, etc.), or pay everyone enough to cover their tax liability, or pay the people who are actually running the business salaries (which would reduce and could eliminate the profits on which everyone's tax liability is calculated). What's incredibly strange and possibly illegal about the OP's situation is that the majority shareholders (parents) are NOT paying the second generation anything and are telling the IRS that they're only paying themselves 60% (i.e., they're skimming off 100% of the profits into their own pockets but probably only being taxed on their 60%, instead of paying themselves salaries consisting of 100% of profits and being taxed on the full 100%).
I don't know which entity it is, but one of the pass through corporations doesn't require equal distributions of profits. I think it's S-Corps require proportional distributions and LLCs do not.
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It is not illegal for OP to pay someone else's tax bill, coz it's paid with after-tax money & OP didn't deduct it from her own taxes, and of course if mutually consented on, i.e. a gift. Just as you can pay someone else's mortgage or tuition, medical or property tax bill. If the parents reported the correct income and filed the correct amount of taxes, the IRS doesn't care who's bank acct the payment comes from. This appears to be a separate issue.
You are absolutely right. Your comment is one of the few rational ones I've seen. So many people are jumping to conclusion and getting excited over this being illegal. It's so interesting reading comments from people who clearly don't know what they're talking about. At the very worst, this is a gift tax issue.
At the very worst it's much worse than that. But as you say we have no idea what the details are and that's why it's better for OP to consult an attorney.
It's not a "gift" if payment is coerced. OP certainly thought something was amiss.
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It is not illegal for OP to pay someone else's tax bill, coz it's paid with after-tax money & OP didn't deduct it from her own taxes, and of course if mutually consented on, i.e. a gift. Just as you can pay someone else's mortgage or tuition, medical or property tax bill. If the parents reported the correct income and filed the correct amount of taxes, the IRS doesn't care who's bank acct the payment comes from. This appears to be a separate issue.
It's perfectly legal to pay someone else's tax bill, but not to mislead the IRS about how much money you're getting. It's a problem if the parents are reporting 60% of profits as their income when they're actually taking 100%. They need to report what they actually distribute to themselves. And it's especially problematic if the parents' tax bill would be higher (due to being in a higher tax bracket) than the OP's tax bill on that same 40%.
I don't know which entity it is, but one of the pass through corporations doesn't require equal distributions of profits. I think it's S-Corps require proportional distributions and LLCs do not.
LLC's may not be required to actually distribute profits, but to my knowledge they ARE required to report what they distribute and to whom as part of the informational return. And they're also required not to commingle funds with their members (such as the parents), or I should say, if the parents commingle the LLC's funds and their own, the parents are putting themselves on the hook personally for any lawsuit that might get filed against the LLC (such as a slip-and-fall by some tenant). In any case we still don't know what kind of entity this is or how old the OP is. LLC's didn't become popular/widespread until the late 90s, so not knowing the OP's age I can't even guess as to how likely it is that this is an LLC.
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It is not illegal for OP to pay someone else's tax bill, coz it's paid with after-tax money & OP didn't deduct it from her own taxes, and of course if mutually consented on, i.e. a gift. Just as you can pay someone else's mortgage or tuition, medical or property tax bill. If the parents reported the correct income and filed the correct amount of taxes, the IRS doesn't care who's bank acct the payment comes from. This appears to be a separate issue.
It's perfectly legal to pay someone else's tax bill, but not to mislead the IRS about how much money you're getting. It's a problem if the parents are reporting 60% of profits as their income when they're actually taking 100%. They need to report what they actually distribute to themselves. And it's especially problematic if the parents' tax bill would be higher (due to being in a higher tax bracket) than the OP's tax bill on that same 40%.
I don't know which entity it is, but one of the pass through corporations doesn't require equal distributions of profits. I think it's S-Corps require proportional distributions and LLCs do not.
LLC's may not be required to actually distribute profits, but to my knowledge they ARE required to report what they distribute and to whom as part of the informational return. And they're also required not to commingle funds with their members (such as the parents), or I should say, if the parents commingle the LLC's funds and their own, the parents are putting themselves on the hook personally for any lawsuit that might get filed against the LLC (such as a slip-and-fall by some tenant). In any case we still don't know what kind of entity this is or how old the OP is. LLC's didn't become popular/widespread until the late 90s, so not knowing the OP's age I can't even guess as to how likely it is that this is an LLC.
I've re-read the original post and OP's replies, and I don't see anywhere she mentions any fraudulent activity such as under-reporting income or playing with tax brackets. Why do we need to assume there's such an issue? As far as we can tell, It sounds the parent's kept 100% of the profits for their own use and other businesses, and purportedly fully reported the full 100%, but then asked her to pay 40% of the legitimately filed taxes.
She appears to have been perfectly OK with this, until the issue comes up of the folks trying to use her payments to fund a home for her dead-beat bro, at which point she feels 'Enough with this, I no longer feel comfortable riding this train...' But the parents have got addicted to the gravy and declare 'It's how the world works! You can't stop now!' To make matters worse, they're not asking any tax payments from the siblings (and we don't know what % ownership said siblings have)
I concur with Honest Abe's assessment that "what really seems to be happening is they are seeking financial assistance from you in some convoluted way. Why else would they "cover" your siblings who can't afford to pay and not cover you?"
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I've re-read the original post and OP's replies, and I don't see anywhere she mentions any fraudulent activity such as under-reporting income or playing with tax brackets. Why do we need to assume there's such an issue? As far as we can tell, It sounds the parent's kept 100% of the profits for their own use and other businesses, and purportedly fully reported the full 100%, but then asked her to pay 40% of the legitimately filed taxes.
She appears to have been perfectly OK with this, until the issue comes up of the folks trying to use her payments to fund a home for her dead-beat bro, at which point she feels 'Enough with this, I no longer feel comfortable riding this train...' But the parents have got addicted to the gravy and declare 'It's how the world works! You can't stop now!' To make matters worse, they're not asking any tax payments from the siblings (and we don't know what % ownership said siblings have)
I concur with Honest Abe's assessment that "what really seems to be happening is they are seeking financial assistance from you in some convoluted way. Why else would they "cover" your siblings who can't afford to pay and not cover you?"
It's not legal for a corporation to work that way. If the corporation is a "pass through" like a subchapter S corporation, then the profits of the corporation are taxable income on each individual owner's personal 1040 return in proportion to their ownership. If the corporation is not a pass through, then the corporation itself files a tax return and pays corporate income tax on the profit. After corporate income tax, the corporation can keep the profits in house as retained earnings, or pay them as a dividend to the owners (who would then pay tax on the dividend income). This is probably pass through corporation since making it a C-corporation or the like would make no sense and incur double taxation.
If the corp is a pass through, then the corporation has to give each owner a form called a Schedule K-1 which details how much they own, and the profit and loss of the business attributable to that ownership share. If the OP is having to pay tax, that is because the OP is getting a K-1. From how the original post is phrased, it very much sounds like the OP is getting a K-1, and reporting it on his 1040 as income.
I am basing this on these two paragraphs specifically:
Unfortunately, that 40% stake means I have to pay taxes on 40% of the profit out of pocket, from my work as a consultant. My parents take 100% of the profit and view the taxes I incur as the "price" of my inheritance. So far, it's left my husband and me on the hook for about $60,000 in extra taxes over our working lives, and my parents still have long lives ahead of them.
I don't feel that the profit from the business should be mine, as I didn't do anything to earn it, but I feel the taxes are a business expense, and so should be covered by the business. I've told my parents as much, but they're adamant this is simply the way the world works. I don't want to cause a rift in the family, but I find the situation more and more unbearable as the years drag on. I just don't see what I can do about it.
If the situation is what I just described, then the parents are filing fraudulent K-1s, both for the OP and siblings. By law, subchapter S corps must distribute profits proportionally to ownership. They don't have to distribute all the profits (or indeed any), but if they do distribute profits, the profits must be distributed proportional to ownership. If this is structured as I described, the parents are engaged in embezzlement and then tax fraud to conceal the embezzlement.
The fair thing to do (since the OP has no moral stake to the 40% even if she has a legal stake) would be to transfer full ownership of the corp to the parents and then just leave it in their estate. It's a $300,000 corp, so the current estate tax really shouldn't be an issue. This would require the parents to pay their proper amount of tax though and not foist it upon their kid, which they seem unwilling to do.
Leaving an inheritance to your children should be an blessing to them. These parents aren't leaving a blessing; they're leaving a mess.
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Forgot to add, it's common to assign shares/pay dividend income to family members for income splitting purposes, but I've never seen one where the main stakeholders (your parents) are leaving you on the hook for taxes for something that you have zero involvement in, hence why I am thinking they are using you as a subsidy more than anything, which would lead me to also believe the business is not cash flow positive/leveraged/not enough working capital/could be a number of things.
Thanks for the input. I sure feel like i'm subsidizing them. For what it's worth, their CPA agrees that the situation is wrong-headed. He's the one who originally advised them to make us, the children, partners, but he doesn't agree with them leaving us the tax bill.
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As above, have you considered buying your siblings shares so you can get majority ownership ASAP?
Alternatively, have you considered selling your 40% stake to an external property investor?
I could buy my siblings out, but that would make me very heavy on real estate, and, while it would give me the legal means to do what I wanted, I'd still have to have the confrontation with my parents.
As far as external investors go, I'm not sure who would be interested in a minority stake in a family business.
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I wonder if you need to decide what is more important - your relationship with your parents or the potential financial advantage.
You also have to factor in the impact that this is having on HER family aka her husband and future children. If you are a little angsty about your parents using your success to help themselves and now your chronically-needing-rescue brother, I imagine your husband is less than thrilled with the arrangement.
When parents pass away and kids grow up and leave the nest, the spouse is the one you are left with. Make sure to support that relationship as well.
He's an awesome guy, and he did totally understandably complain about it for a while. It made for some heated discussion in the beginning. We're both on the same page about it, and can discuss it cooly now.
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It sounds to me like a strange set up having to pay taxes when there are apparently profits that create the taxes and could therefore pay the taxes. However, I think a lot of people responded by saying that the OP has a right to 40% of the profits because they own 40% of the company. I disagree. The parents set up the company this way to avoid inheritance tax (presumably), so the "ownership" is really just a construct to enable things to be advantageous to the family (vs. the IRS) in the future. To then turn around and say that the OP should claim 40% of the profits seems misdirected to me. It's like putting a car in your wife's name (for whatever reason) and then she won't let you drive it.
On all the rest (getting a lawyer/accountant involved, talking to the parents, possibly giving up ownership) I agree.
The problem is that if OP is paying tax on 40% of the profit, but the parents are actually getting that profit, the OP's parents are engaged in tax fraud. I'm not saying the OP has an entitlement to 40% of the profits, but the problem is that this arrangement is a crime. The only way this would be legal would be if the parents did not take any distributions for themselves either, and just left all the profits in the company (possibly using them to keep buying real estate). If the parents are taking distributions and then saying those distributions went to the OP, that is criminal tax fraud and they can go to jail.
I'm pretty sure they're not engaged in fraud. Their lawyer and CPA both say this is on the up and up. It just remains to be dcided how far my husband and I want to push to get the taxes paid.
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To clarify, I don't think anything illegal is happening. I think my parents are wrong on this issue and I feel like they're taking advantage of me, but that doesn't make them criminals. I also trust their accountant, who wouldn't risk his reputation in the community in order for a couple of clients to get a illegal $60,000 tax break.
My husband and I need to decide how far we're willing to push the issue, and what we're comfortable with losing, financially and personally.
On a positive note, after a family meeting, my brother is going to rent an apartment from a third party, so at least that's been settled.
Thanks to everyone who's commented.
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To clarify, I don't think anything illegal is happening.
You could be right, but then you're not a lawyer and you don't even know what kind of business structure this is (LLC, S-corp...), which suggests that there are a lot of details about this business and its finances that you don't know. In other words, there's not really any basis for you to feel confident that your belief about whether they're breaking the law is correct. Especially since some lawyer/accountant types on this thread have all pointed out potentially serious tax/legal issues with what your parents are doing. We're not trying to insult your parents or drag their reputations through the mud when we say what they're doing may be illegal. It's possible to commit criminal tax fraud without even realizing that what you're doing is a crime.
That is just one of the reasons that I was suggesting you spend a couple hundred bucks talking to a competent lawyer with a background in small business, tax, and ideally (but not necessarily) also estates and trusts.
Glad to hear about the positive development re: your brother. That's good.
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Forgot to add, it's common to assign shares/pay dividend income to family members for income splitting purposes, but I've never seen one where the main stakeholders (your parents) are leaving you on the hook for taxes for something that you have zero involvement in, hence why I am thinking they are using you as a subsidy more than anything, which would lead me to also believe the business is not cash flow positive/leveraged/not enough working capital/could be a number of things.
Thanks for the input. I sure feel like i'm subsidizing them. For what it's worth, their CPA agrees that the situation is wrong-headed. He's the one who originally advised them to make us, the children, partners, but he doesn't agree with them leaving us the tax bill.
That's what I didn't understand. The point of making you partners early is that the "gift" is under the taxable threshold at that time and (hopefully) when your parents die the value of the partnership is above the taxable threshold.
If they now consider these extra tax payments "buying" your inheritance, well they could have done that without any shenanigans whatsoever. Just sell you shares each year. But then they'd have to report capital gains on the sales of the shares.
So it appears they are trying to make a sale look like two gifts:
One from them to you in childhood making you a partner
One from you to them now ("taxes")
The IRS may not be happy with this and honestly if I were you I'd try to get this thread deleted.
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Forgot to add, it's common to assign shares/pay dividend income to family members for income splitting purposes, but I've never seen one where the main stakeholders (your parents) are leaving you on the hook for taxes for something that you have zero involvement in, hence why I am thinking they are using you as a subsidy more than anything, which would lead me to also believe the business is not cash flow positive/leveraged/not enough working capital/could be a number of things.
Thanks for the input. I sure feel like i'm subsidizing them. For what it's worth, their CPA agrees that the situation is wrong-headed. He's the one who originally advised them to make us, the children, partners, but he doesn't agree with them leaving us the tax bill.
That's what I didn't understand. The point of making you partners early is that the "gift" is under the taxable threshold at that time and (hopefully) when your parents die the value of the partnership is above the taxable threshold.
If they now consider these extra tax payments "buying" your inheritance, well they could have done that without any shenanigans whatsoever. Just sell you shares each year. But then they'd have to report capital gains on the sales of the shares.
So it appears they are trying to make a sale look like two gifts:
One from them to you in childhood making you a partner
One from you to them now ("taxes")
The IRS may not be happy with this and honestly if I were you I'd try to get this thread deleted.
Yes +1
To clarify, I don't think anything illegal is happening.
You could be right, but then you're not a lawyer and you don't even know what kind of business structure this is (LLC, S-corp...), which suggests that there are a lot of details about this business and its finances that you don't know. In other words, there's not really any basis for you to feel confident that your belief about whether they're breaking the law is correct. Especially since some lawyer/accountant types on this thread have all pointed out potentially serious tax/legal issues with what your parents are doing. We're not trying to insult your parents or drag their reputations through the mud when we say what they're doing may be illegal. It's possible to commit criminal tax fraud without even realizing that what you're doing is a crime.
That is just one of the reasons that I was suggesting you spend a couple hundred bucks talking to a competent lawyer with a background in small business, tax, and ideally (but not necessarily) also estates and trusts.
Glad to hear about the positive development re: your brother. That's good.
I'd suggest the same - shell out a few hundred to talk to a lawyer specializing in this kind of thing. It used to be de rigueur to set up family limited partnerships where the kids had noncontrolling interest and the parents owned a small percentage but held all of the power; a couple of people on this thread are very familiar with that sort of arrangement.
You need to see their books; you may not feel comfortable, since you know that the accountant is talking to your parents, but you have the full right to bring in an auditor and see what's going on.
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The IRS may not be happy with this and honestly if I were you I'd try to get this thread deleted.
There are too many independent professionals involved, three accountants and one lawyer now that I think about it, who would have to be willing to risk their reputations for the kickbacks my parents would supposedly pay out of the $60,000 they've saved by me paying that chunk of the taxes over the past 10 years. It just wouldn't make sense for them all to take such a risk that when we're talking about such small sums. Plus, I know these people. They're really boring (in a good way), eagle scout types with a lot to lose.
I will have a look at the books myself, though, along with my accountant. If nothing else, I won't be so cllueless about the structure of the partnership afterwards. Thanks for the advice!
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Bronze,
I'm a CPA so I deal with items like this regularly. While everything your parents are doing is likely very legal and above board, nothing they are doing sounds fair to you. A few points/clarifications from yours and other comments:
1) Someone mentioned you are entitled to 40% of the profits. While this is correct, and I'm sure 40% of the profits are allocated to you on your K-1 each year, this does not "entitle" you to 40% of the available cash every year. Most partnership agreements will provide for a payment of cash to cover your tax liability, but some simply don't. It doesn't sound like your partnership is required to make "tax distributions" since it isn't.
2) If your parents have control of the partnership, which they can have in various ways, they have full authority to make any decisions related to the operations, including what to do with all the cash. If they are General Partners and you are a limited partner, it's likely they have full control, even if they only own 1% of the partnership.
3) Someone else mentioned a partnership requires a pro-rata distribution (i.e.-you own 40% so you get 40% of all cash distributions). I believe they are confusing partnerships with S-Corps. Partners in a partnership can take a "draw" from their equity, however this is likely subject to approval of the controlling partner. This does not have to be pro-rata. In direct contrast, S-Corps are required to pay pro-rata distributions at all times to avoid major IRS consequences.
4) MOST IMPORTANT ITEM - This one is in your favor substantially; therefore it's likely detrimental to your parents - By paying taxes on your profits, but not actually receiving any of the cash, you have built up a very large partnership basis. This means when your interest is sold, the building is sold, or you obtain control of your future cash "draws", you will not be paying much tax. If the building is sold you will likely pay capital gains, but your "Partnership Basis/Cost Basis" for the sale will be very large due to all the profits you've paid taxes on. If you sell your partnership interest the same thing is true, lower taxes due to your current situation. When/if you ever gain control of the partnership, or when you are able to begin drawing cash out, you will not pay taxes on the cash you take out. You will continue to pay taxes on the profits, but not the cash. However, all cash you take out will reduce your partnership basis (cost basis in the partner interest).
Summary - It's likely legal, but not fair based on all the facts you provided. I'm glad they decided not to fund your brother's lifestyle with your company. If you stick with it you will have some major tax benefits in the long run once you start to see some cash from this operation.
And no, you are not an ungrateful future heir. Good Luck.