Categorizing Service Agreement Expenses Billed to Holding Company

TWAE · ‎December 26, 2022

I have a Holding LLC which leases equipment, off-road vehicles, and buildings to a subsidiary LLC which functions as a landlord for the other operating subsidiary LLCs as part of a service agreement between the Holding LLC and the Landlord LLC.

Part of the service agreement is that the Holding LLC will compensate the Landlord LLC for expenses incurred while functioning as the landlord. Examples of this are milage related to operating our facility, large purchases, and the travel expenses of Holding LLC Members who are traveling to our location out of town. Additionally, since we have a tax-exempt Amazon Prime account, when the Landlord LLC purchases items from Amazon, it marks them up 10% and charges them to the Holding LLC.

The Landlord LLC provides the Holding LLC an itemized invoice each month which the Holding Company pays.

My question is if the payments from the Holding LLC under the service agreement have to be itemized or if I can just lump them all as an expense under the Service Agreement with the invoice as the supporting documentation?

For example, if the Landlord LLC incurs $2000 in expenses for the month.
$500 in diesel for vehicles
$250 in office supplies
$250 in Member non-milage travel expenses
$500 in milage
$500 in utilities.

Can the Holding LLC just categorize all of that as a Service Agreement expense, or would they have to be categorized as though the Holding LLC had incurred them itself?

In case it makes a difference, for taxes, the Landlord LLC is a single-member disregarded entity, while the Holding LLC is taxed as a partnership.

Rainflurry · ‎December 28, 2022

@TWAE

I'd be rather skeptical that a Service Agreement is a magical cloak which makes everything 100% deductible for the entity paying the bills. And even if it were, I'd be rather leery of doing that, as I imagine it wouldn't look very good during an audit.

If the Holding LLC receives an invoice from the Landlord LLC with the breakdown of the charges, there's nothing improper about entering those expenses as a single line-item expense under 'Service Agreement'. Presumably, you have an actual Service Agreement document between the Landlord LLC and the Holding LLC? If you were to be audited, the IRS would most certainly ask for the actual invoice (and the Service Agreement) to substantiate the expense regardless if you entered the expense as a single line item to Service Agreement or broke it down by the individual line items. The bottom line is that, as long as these are all ordinary and necessary expenses (which it sure sounds like they are), it doesn't matter which method you use. The supporting documentation will be required either way in the case of an audit. Referring back to my previous post, it really depends on what level of detail you want on your P&L for internal reporting purposes.

I was a controller for a retail company for many years. We entered many millions of dollars in inventory purchases to an inventory asset account annually without breaking down the purchases by item detail. We always had the vendor bill to substantiate the specific breakdown in case of an audit. Since we didn't use QB for inventory tracking, it would have been time/cost prohibitive to track that level of detail in QB. I think your situation is similar.

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Rainflurry · ‎December 27, 2022

@TWAE

My $.02 is that it really comes down to how much detail you want on your financial statements. For example, if you want to be able to show the breakdown of utilities, diesel, etc, on the P&L for the partners, then, obviously, you need to enter them as separate line item expenses. If the partners are ok with just a flat "Service Agreement" expense on the P&L, then you can certainly go that route. I would suggest any astute partner would prefer to see a breakdown, especially if you personally are the single-member landlord LLC and earning a profit on the Service Agreement.

TWAE · ‎December 27, 2022

The subsidiaries are all wholly owned by the same Holding LLC, so eventually everything will flow up the the holding LLC on a Schedule C.

The reason I have the Holding LLC reimbursing the Landlord LLC is to ensure that the Holding LLC as the single-member of the Landlord LLC will maintain positive equity for the year. Due to a fire destroying significant assets, the Holding LLC will be taking a huge loss for the year. But the Members have plenty of equity in the Holding LLC to take the loss. Since the Landlord LLC was mostly financed with loans, there's little room in the equity account for loses this year. Next year, the plan is for the Landlord LLC to become self-sustaining by generating its own revenue, but that's not in the cards this year.

My question is more from the perspective of ensuring that the Holding LLC's books are solid when we eventually get audited. Since meals are part of the expenses invoiced to the Holding LLC, I don't know if those need to be segregated at the Holding LLC level. In this case, they're all travel-meals at restaurants and 100% deductible, so I'm assuming its not a major factor for this year

What I'm not sure about, is if the Landlord LLC incurred expenses under its service agreement which were 50% or 0% deductible (such as non-restaurant travel meals, entertainment, etc), and then billed those to the Holding LLC under the Service Agreement.

I'd be rather skeptical that a Service Agreement is a magical cloak which makes everything 100% deductible for the entity paying the bills. And even if it were, I'd be rather leery of doing that, as I imagine it wouldn't look very good during an audit.

All the expenses incurred are legitimate. If I were called to the mat by the IRS, I wouldn't have a problem explaining how they are all tied to the Landlord LLC's providing of services to the Holding Company. It's not like I'm spending $500 a month on single-malt scotch and billing it to the Holding LLC as a 100% deduction.

I'm certainly going to have a CPA review things before I send in my taxes for the year. But I want to avoid handing them a dumpster fire of records they have to do an archeological expedition on.

Rainflurry · ‎December 28, 2022

@TWAE

I'd be rather skeptical that a Service Agreement is a magical cloak which makes everything 100% deductible for the entity paying the bills. And even if it were, I'd be rather leery of doing that, as I imagine it wouldn't look very good during an audit.

If the Holding LLC receives an invoice from the Landlord LLC with the breakdown of the charges, there's nothing improper about entering those expenses as a single line-item expense under 'Service Agreement'. Presumably, you have an actual Service Agreement document between the Landlord LLC and the Holding LLC? If you were to be audited, the IRS would most certainly ask for the actual invoice (and the Service Agreement) to substantiate the expense regardless if you entered the expense as a single line item to Service Agreement or broke it down by the individual line items. The bottom line is that, as long as these are all ordinary and necessary expenses (which it sure sounds like they are), it doesn't matter which method you use. The supporting documentation will be required either way in the case of an audit. Referring back to my previous post, it really depends on what level of detail you want on your P&L for internal reporting purposes.

I was a controller for a retail company for many years. We entered many millions of dollars in inventory purchases to an inventory asset account annually without breaking down the purchases by item detail. We always had the vendor bill to substantiate the specific breakdown in case of an audit. Since we didn't use QB for inventory tracking, it would have been time/cost prohibitive to track that level of detail in QB. I think your situation is similar.

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Categorizing Service Agreement Expenses Billed to Holding Company