Tax Tips From Bradstreet & Associates - How Are LLC Members Taxed?
There are many issues surrounding the issue of Self-Employment (SE) tax liability for LLC members. As you will read, we have been waiting on final regulations for 20 years!
Question: Is a limited partner (or LLC member who is not a managing member) subject to self-employment taxes on the trade or business income from the partnership?
Answer: It depends. The tax code [Section 1402(a)(13)] excludes the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described in the code [§707(c)] to that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services.
In 1997, proposed regulations define a limited partner, which includes similarly situated LLC members. Prop. Reg. §1.1402-2(h)(2) states that an individual is treated as a limited partner, and therefore won’t be subject to SE tax, unless he or she does any one of the following:
1. Has personal liability as defined in Reg. §301.7701-3(b)(2)(ii) for the debts of or claims against the partnership by reason of being a partner.
2. Has authority under the law of the jurisdiction in which the partnership is formed to contract on behalf of the partnership.
3. Participates in the partnership's trade or business for more than 500 hours during the partnership's taxable year.
Furthermore, a service partner in a service partnership may not be a limited partner. A partner is not considered to be a service partner if that partner only provides a de minimis amount of services to or on behalf of the partnership. A service partnership is a partnership that substantially all the activities of which involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science or consulting [Prop. Reg. §1.1402-2(h)(5) and (6)].
There was opposition to these proposed regulations in the Taxpayer Relief Act of 1997. Congress provided that the IRS cannot issue any final or temporary regulations in this area until July 1, 1998. The IRS and Congress still have not issued any further guidance. However, taxpayers following these proposed regulations can use them as substantial authority in the case they are questioned by the IRS.
As always, give us a call if you have any questions. You can contact us in Dayton at 937-436-3133 and in Xenia at 937-372-3504. Or visit our website.