Your Detailed Tax Review Report

Nicolette Yearde, CPA, EA, MTax

LPB Tax and Accounting Services

TestCo LLC

Partnership (Form 1065) Tax Year 2025

Business Tax Review

1. EXECUTIVE SUMMARY

- Revenue: $500,000

- Net income (book/taxable business income before owner-level items): $90,000

- Net margin: 18.0%

- Federal tax balance: $0

- State: California; business has multi-state activity and retained earnings

- Audit risk flags reported: None

This memorandum summarizes the partnership tax position for 2025, highlights potential tax savings and compliance items, quantifies key opportunities, and lists recommended year-end actions. Primary near-term items: maximize tax-favored retirement contributions, verify California filing obligations and potential LLC fee, document multi-state apportionment, and confirm QBI planning for partners. Dollar estimates below are calculated using the provided $90,000 net income and are presented as estimates for planning. We will perform final calculations once partner allocation and individual tax positions are available.

2. ENTITY STRUCTURE ANALYSIS

- Current classification: LLC taxed as a partnership filing Form 1065.

- Advantages retained: Partnership flow-through avoids entity-level federal tax. Flexibility in allocating income, losses, guaranteed payments and distributions.

- Considerations:

- Self-employment tax exposure: Active partners typically have net earnings subject to self-employment tax. With $90,000 of business net income, partners face meaningful SE tax unless other compensation structures are used.

- Retained earnings: Partnerships retain capital in the entity without entity-level tax, but retained earnings affect partner capital accounts and basis. Ensure retained amounts are supported by capital accounts and partner agreements when profits are not distributed.

- Multi-state activity: Filing obligations and apportionment rules vary. California obligations should be confirmed for income apportionment, withholding, and LLC fees. Nexus in other states may create nonresident filing and withholding responsibilities.

- Suggested structural review: A targeted analysis comparing continued partnership taxation to an S corporation conversion or other entity options for owner-level SE tax and payroll tax tradeoffs. We can prepare a model if you want a side-by-side comparison.

3. DEDUCTION GAPS IDENTIFIED

Potential deductions and documentation items that may be underutilized or at risk without better documentation:

- Retirement plan contributions: No plan identified in provided facts. With $90,000 net, a SEP or Solo 401(k) could shelter taxable income. Estimated SEP contribution capacity for an active partner is about $16,700 (see section 5). Establishing a plan allows significant tax-deferral.

- Health insurance for partners: Partnership-paid health insurance should be structured as guaranteed payments and reported on K-1s so partners can claim self-employed health insurance deduction at the individual level.

- Section 179 and bonus depreciation: If capital purchases were made or are planned, ensure proper election of Section 179 or bonus depreciation to accelerate deductions. This can materially reduce taxable income.

- Meals, travel and vehicle expenses: Ensure adequate contemporaneous records for business meals and mileage. Business meals generally 50 percent deductible in 2025, with strict substantiation rules.

- Home office and occupancy allocations: If partners use home offices for partnership business, document time and space usage and expense allocation.

- State apportionment and nexus documentation: For multiple states, retain receipts and method worksheets used in allocating income. Errors here can generate state adjustments and penalties.

- Retained earnings documentation: Minutes or partner resolutions supporting reasons to retain earnings will reduce partner disputes and support capital treatment.

4. QBI DEDUCTION ANALYSIS

- Tentative partnership-level qualified business income (QBI): assume full qualified income of $90,000.

- Potential 199A pass-through deduction (federal): 20% of QBI = $18,000, subject to partner-level taxable income and other limitations.

- Practical notes:

- Because partnership-level QBI is passed through to partners, the actual deduction realized depends on each partner’s taxable income, W-2 wages, and UBIA of qualified property. With $90,000 of business net income, partners with modest other income are likely to obtain the full 20 percent deduction at the partner level.

- California does not conform to the federal QBI deduction. Partners who are California residents will not receive a corresponding state deduction for the 199A amount on their California returns.

- If the partnership has little or no W-2 wages, wage-based limitations should not bind at a $90,000 net level for most partners, but confirm per-partner taxable income thresholds and the presence of guaranteed payments that may affect QBI calculations.

5. SE TAX AND SALARY OPTIMIZATION

- Estimated self-employment tax on $90,000 net income (single active partner approximation):

- Self-employment tax base = 0.9235 × $90,000 = $83,115

- Self-employment tax = $83,115 × 15.3% ≈ $12,710

- Deductible portion of SE tax (for income tax) = half ≈ $6,355

- Retirement planning interaction:

- Estimated maximum SEP contribution for an active partner is approximately 20% of net earnings after deducting half of SE tax. Using the above numbers, estimated maximum SEP contribution ≈ $16,730. This is an estimate only. Solo 401(k) alternatives may allow larger combined employer and employee contributions depending on wages and plan design.

- Salary optimization opportunities:

- Because partners are generally not employees, partnership guaranteed payments are subject to SE tax. Converting to an S corporation structure can, in some circumstances, allow owner compensation in the form of W-2 wages and distributions that are not subject to self-employment tax. For a partnership, consider whether paying a higher amount as guaranteed payments versus distributions is appropriate.

- We recommend a formal analysis comparing continuing partnership classification to an S corporation election for 2026 and beyond. This comparison should include payroll taxes, employer payroll filing requirements, retirement plan effects, and state treatment, especially California conformity.

6. 2025 TAX LAW UPDATES

- Inflation adjustments: Expect routine inflation adjustments for tax brackets, standard deduction, and retirement plan contribution limits. Confirm specific 2025 IRS notices when available.

- Retirement plan contribution limits: Contribution limits for 401(k), SIMPLE, and other plans generally increase with inflation. Confirm limits before making year-end elections.

- State conformity and California specifics:

- California continues to have its own conformity rules. It does not conform to the federal QBI deduction for individual returns in recent years. Confirm for 2025 when preparing returns.

- California requires an annual LLC tax of $800 for entities doing business in the state. In addition, California imposes an LLC fee based on total income. For total income of $500,000 the expected California LLC fee bracket is the $500,000 to $999,999 range, which historically has resulted in a fee of approximately $2,500. This should be confirmed with current FTB instructions for 2025.

- Meals and entertainment: Business meal deduction rules returned to 50 percent for 2025 for most meals. Entertainment expenses remain nondeductible.

- Filing deadlines and plan setup: Certain retirement plan actions must be taken by year-end to capture employee deferrals. SEP contributions may be funded by the extended tax filing deadline but plan establishment timing matters.

7. AUDIT RISK ASSESSMENT

- Reported audit flags: None.

- Residual risk areas to monitor:

- Multi-state apportionment and nexus issues can trigger state audits. Maintain strong documentation of sourcing, payroll and sales apportionment factors, and where services are performed.

- Retained earnings and unusual distributions without supporting capital account statements may prompt questions. Maintain up-to-date capital account schedules and partner resolutions explaining retained earnings use.

- Related-party transactions and guaranteed payments need contemporaneous documentation and reasonable compensation support.

- Meals, travel and vehicle expenses require contemporaneous logs and purpose documentation.

- Overall audit risk: Low to moderate, given the absence of obvious large or unusual items, but multistate exposure and retained earnings require good documentation.

8. TOP 6 RECOMMENDATIONS

1. Establish a retirement plan before year-end or, if a SEP is preferred, calculate and document the SEP contribution. Estimated SEP contribution capacity for an active partner is approximately $16,730 for 2025 based on $90,000 net income. Exact contribution depends on finalized SE tax and partner allocations.

2. Confirm California filing obligations. Budget for the $800 annual LLC tax and the estimated $2,500 California LLC fee based on $500,000 total income. File Form 568 and any required state returns with accurate apportionment.

3. Document multi-state apportionment methodology and retain supporting records for sales, payroll and property factors. This reduces state audit risk and prevents costly adjustments.

4. Preserve QBI benefit by confirming QBI eligibility and providing partners with sufficient detail to claim the 20 percent deduction at the partner level. Estimate potential federal QBI deduction equal to $18,000, subject to partner-level limitations.

5. Evaluate entity structure and compensation strategy. Run a formal model comparing continued partnership treatment to an S corporation election to quantify potential self-employment tax savings net of additional payroll compliance costs.

6. Strengthen expense substantiation and capture all allowable deductions. Impl

[]