Can you explain how the "gross up" works? Do you just pay them more to cover the taxes, or is there some specific calculation?

We basically increase the payment amount to account for the roughly 15.3% self-employment tax they'll owe. So if we want them to net $1,000 after SE tax, we'd pay about $1,180 instead. There's no perfect calculation because their actual tax situation depends on all their other income and deductions, but this is a rough approximation that helps prevent surprises. We record the full grossed-up amount as the guaranteed payment on their K-1.

There's a narrow exception if the LLC has elected to be taxed as an S-Corp (not a partnership) AND the payments are for services outside the member's normal owner duties. But that's clearly not the case for the original poster since they file Form 1065 as a partnership.

Oh man I hadn't even thought about state taxes. I'm in Virginia - do you know if they handle 401k distributions the same way the feds do?

Virginia generally follows the federal treatment of retirement distributions, so if it's taxable for federal purposes, it will likely be taxable for Virginia as well. However, Virginia has its own deductions and credits that might help offset some of the additional income. I'd recommend checking the Virginia Department of Taxation website or contacting them directly. You might need to file an amended state return as well. Virginia's statute of limitations for tax assessments is generally 3 years, so they could potentially come after you for this even if they haven't yet.

This is good advice. I set up an installment agreement for about $40k a few years ago. Process was actually pretty straightforward online for amounts under $50k, but for $65k you'll probably need to call and talk to someone. They'll ask about your monthly expenses and income to determine what you can pay.

Is that true across all states? I'm in Florida and starting a similar business. Did your broker explain why there's a difference in rates between the two structures?

From what our broker explained, it's not universal across all states but is common in many. The difference comes from how insurance companies assess risk based on historical claims data. They have more data on contractor LLCs than LLPs since LLCs are much more common in the construction industry. In Florida specifically, I've heard the difference can be even more pronounced because of how your state handles construction defect claims and the associated liability. Insurance companies have specific rating factors for different business structures, and LLCs in contracting tend to have more favorable loss histories in their actuarial data. Definitely worth getting quotes for both structures from a broker who specializes in contractor insurance.

Can you explain more about how that works? We're just starting but hoping to grow quickly. How complicated was switching to S-Corp taxation?

What's considered "reasonable" though? That seems super subjective. I do cybersecurity consulting and charge $175/hr but only take home about $80k in salary and the rest as distributions. Is there some formula or percentage that's considered safe?

The R&D tax credit is intriguing - I develop custom solutions for clients frequently. What kind of documentation is needed to support R&D credit claims? I keep detailed time logs already, but wonder if there's specific additional documentation I should be maintaining.

For R&D credits, you'll want to maintain several types of documentation. Time tracking is a good start, but break it down to show which hours were spent on activities that qualify (experimentation, development of new techniques, solving technical uncertainties) versus routine work. Keep design documents, project plans, and technical specifications that show the innovation challenges you were addressing. Emails or meeting notes discussing technical problems and proposed solutions are valuable. Document testing procedures and results, especially failed approaches that led to new directions. It's also helpful to have a narrative for each project explaining why it required innovation rather than just applying existing solutions.

Do you need to get separate EINs for each business activity? I'm doing web design 1099 work but also selling digital products, and I'm not sure if I need two tax IDs or can use my SSN for both.

You don't need separate EINs for different business activities as a sole proprietor. You can use your SSN for both businesses on your Schedule Cs. Many sole proprietors don't have EINs at all and just use their SSN, though you can get an EIN if you prefer not to use your SSN for business purposes. If you did get an EIN for one business activity, you could still use your SSN for the other, or get separate EINs, but it's not required. The important part is keeping the income and expenses separate for accurate reporting on different Schedule Cs.

Is there any way to reduce the self-employment tax hit? It seems so much higher than when I was a W-2 employee.