Don't Let Sweat Equity Create 'Phantom Income'
How to set up an LLC without creating taxable income for your sweat-equity partner
Q: I'm planning to start a business with a longtime friend who has just been downsized from a large corporation and needs a job. I would provide $50,000 in startup cash, and he would basically do all the work. We would form a limited liability company (LLC) for the business and split profits and losses 50/50. Are there any legal or tax issues we need to think about?
A: There shouldn't be, but, sadly, there are. The problem is that our tax code places a value on capital (the money you put into the business) but not labor or "sweat equity" (the future services your partner will perform for the business). If you put $50,000 into this company and give your partner a 50 percent interest in the LLC, the IRS will value his interest at $50,000. Your partner will be required to pay taxes on that "phantom income," and he won't be happy about that.
Continue reading this article - and everything on Entrepreneur!
Become a member to get unlimited access and support the voices you want to hear more from. Get full access to Entrepreneur for just $5.
Entrepreneur Editors' Picks
-
When Her Parents' Restaurant Burned Down, This First-Generation Founder's Hot Sauce Brand Rose From the Ashes to Take on Corporate Giants
-
Not Hitting Your Goals? Here's How to Know If You Should Change Tactics or Strategy.
-
You Can Generate Your Own Viral LinkedIn Post With This Hilarious Tool
-
This Couple Lost Everything When the Housing Market Crashed. But Manifesting 'Magic' Helped Them Launch a Metaphysical Brand With 10 Stores.
-
The Best Software Solutions and Tech Providers in the Franchising Industry
-
This 18-Year-Old Student Wanted a Better Way to Keep Track of His School Work. So He Built an App — and a Business.
