Taxation of Services as Capital Contribution to a New LLC

So if I contribute like $500 cash along with my services would that help at all? Or is that too small an amount compared to the value of the services I'd be providing? My partner is putting in about $20,000 cash and we're splitting ownership 50/50.

The $500 contribution alongside services would likely not help much in your situation. The IRS would probably view this as a disproportionate arrangement if you're getting 50% ownership with only $500 cash while your partner contributes $20,000. If your services truly have a fair market value equivalent to $19,500 (the difference between your cash and your partner's), then you'd likely still need to recognize that $19,500 as taxable income. The IRS looks at substance over form, so adding a token cash amount doesn't change the underlying reality that you're receiving ownership primarily in exchange for services.

Does taxr.ai actually give specific advice on structuring the operating agreement? I've been trying to find someone who can help with this exact issue but my local accountant doesn't seem to fully understand LLC partnership tax issues.

I'm skeptical about online tax services. How does this compare to just hiring a CPA who specializes in business formation? Wouldn't a human tax professional be better for something complicated like partnership structures?

They absolutely provide specific advice on operating agreement structures. When I uploaded our draft, they highlighted exactly which clauses would create immediate tax consequences and suggested alternatives that could help with tax deferral strategies while staying compliant. Compared to a CPA, I actually found the AI analysis more thorough on this specific issue. My regular accountant gave generic advice, but taxr.ai provided specific section-by-section feedback with IRS citation references. Plus I didn't have to wait weeks for an appointment or pay hourly rates. The AI analyzes the documents instantly and human tax experts review the output for accuracy.

How does this actually work? Like, does it just keep dialing the IRS for you, or is there more to it? I've been on hold with the IRS for literally 3+ hours before giving up.

This sounds like BS honestly. The IRS is notoriously impossible to reach. No way some service magically gets you through when millions of others can't get through. And even if you do get through, the IRS agents often give conflicting answers to the same question. Sounds like a waste of money to me.

It works by using their priority line system that constantly redials and holds your place in the queue so you don't have to stay on the line yourself. When an agent finally picks up, you get a call connecting you directly to them. No more waiting on hold for hours. I totally get the skepticism. I felt the same way! After spending multiple days trying to get through and getting disconnected each time, I was desperate. What surprised me was that not only did I get through, but I was connected to someone in the business tax department who actually understood partnership taxation. The agent walked me through the specific rules for service contributions and capital accounts. Definitely not the generic answers you might expect.

This sounds like it might work for my situation. Is there a specific way the operating agreement needs to be worded for this to work properly? I'm concerned about getting this wrong and creating problems down the road.

The operating agreement should explicitly state that you're receiving profits interests rather than capital interests. It should specify that upon liquidation of the LLC immediately after you receive your interest, you would receive nothing (meaning you have no immediate capital value). Your operating agreement should also clearly define how profits will be allocated going forward - in your case, 50/50 despite the unequal capital contributions. You'll want to have your tax professional review the specific language to ensure it meets the IRS safe harbor requirements for profits interests. The IRS has Revenue Procedure 93-27 that provides guidelines specifically about this topic.

Would it help if OP just made a loan to the business instead of contributing services? Then couldn't they just get paid back over time without the immediate tax hit?

This is incredibly helpful - the self-employment tax angle is something I hadn't even considered! So you're saying I could potentially be looking at both regular income tax AND the 15.3% SE tax on the same contribution? That would be brutal. Did you find any way to minimize the SE tax portion, or is that just unavoidable when contributing services? And how did you handle the cash flow issue when you owed taxes on income the LLC hadn't actually generated yet? I'm trying to figure out if I should just bite the bullet and contribute some cash instead to avoid this whole mess.