S-Corporation renting from a "sister organization

[Horseaddict]

I have customers who are members of a S-Corp that want to reduce taxable income, and have decided to begin paying rent to a Sister organization, meaning the same 4 members are also partners of the sister organization. I don't feel this will accomplish what they are hoping to do.  Is there a benefit to this action?  I want to meet with them and see if there is another option if this isn't what they need.

I hope this makes sense 🙂

[IRonMaN]

I'm not sure how taking money from your left pocket to put it into your right pocket is going to save taxes. 

[Horseaddict]

I agree.  I just wondered if I was somehow missing something.  My suggestion is to provide employees with a flex account, HSA or something similar.

[sjrcpa]

@IRonMaN Jeff, I was going to say the same thing.

[BobKamman]

Can't really answer without knowing whether Sister is also an S.  

[Horseaddict]

Currently it is a partnership.  They want to start a SEP, but not include employees (restaurant), so they will use the partnership to open a SEP for the partners.  I believe they will need to restructure the partnership to S-Corp so they can pay salaries.  I would be interested if anyone here can offer any advice in this matter.  I just spoke to one of the members and this is what she told me.

Thanks,.

[sjrcpa · Accepted solution]

For the new partnership, how would they turn rental income into self-employment income?

And what would the partnership own that it would rent to the S Corp?

Also, have them look into the pension rules for commonly controlled businesses and/or affiliated service groups.

[Horseaddict]

Thank you for the response.  The S-Corp is a restaurant and the partnership owns the building the restaurant operates from.as well as other residential rental properties. 

I will suggest that they ask about the pension rules issue, thank you.

[BobKamman]

Is the partnership generating passive losses that the owners can't deduct?  They may want it to "break even" by increasing the rental income it collects.  

[Horseaddict]

No returns have been done.  That will be my project this tax season.  I believe returns going back to 2022 will be necessary.  I haven't seen any P&L or Balance sheet yet, so I am not sure what to expect.

[Taxes-by-Rocky]

You can't blame the owners for wanting to purchase real estate they may have previously leased from a third-party (i.e., so as to build equity, for asset protection purposes, etc.).  And yes, sounds like they are 'entities under common control' but it may not matter if the partnership does not generate earnings from self-employment - no one buys a building to get rid of the 2.9% Medicare tax (you would have paid the rent somewhere).  While it's unlikely you'll get material participation by the partners, if deemed a self-rental generating passive loss / nonpassive income, it's possible the other rentals in the partnership may generate passive income.  At least then it's all in one place (saving NIIT for a while). After all, depreciation on rehabs is fairly lucrative right now.

[Taxes-by-Rocky]

That SEP profit sharing contribution would have to go to the restaurant's employees as well (assuming entities under common control). IRC 414(c)....and the horrid retirement plan rules that follow.....

[qbteachmt]

"and the partnership owns the building the restaurant operates from.as well as other residential rental properties."

It's not a good idea for S Corps to own real estate.