Thread: LLC; Self Employment Tax Watch

Tax Watch
LLC Self-Employment Regulations Can Be Taxing

By Steven M. Friedman and Samuel H. Hoppe

LLC Members IRC 1402 & SET Dilemma
Distinguishing LLC Members Qualified as Limited Partners vs. General Partners Subject to SET

[Ed: IRC Section 1402(a)(13) exempts limited partners from Self Employment Tax. Article
discusses application of aforementioned section to nonmanaging LLC Members as corollary to
limited partners as an entity planning opportunity to avoid FICA and SET.]

Section 1402(a) generally defines net earnings from self-employment for
purposes of determining a tax base to which self-employment taxes will be
applied. Specifically, net earnings for self-employment include the distributive
share of income or loss from any trade or business carried on by a partnership.

However, Section 1402(a)(13) provides an exception, stating that the distributive
shares of income or loss of limited partners, other than guaranteed payments,
will be excluded from net earnings from self-employment income. Accordingly,
limited partners or members of a partnership or LLC are exempt from paying
self-employment taxes on their distributive share of income or loss. The issue — and
the controversy among taxpayers over who is liable for self-employment taxes — stems
from how the statute defines a limited partner for purposes of determining net
earnings from self-employment.

Limited Partner Defined
The definition of a limited partner has narrowed in recent years, ultimately making
it more difficult for LLC members to qualify for the limited partner exception of
Section 1402(a)(13). For example, Section 1402 regulations that were proposed in
1994 — but never were finalized — made a distinction between individuals owning
an interest in limited partnerships and those owning interests in LLCs. Specifically,
under the 1994 regulations, a taxpayer owning an interest in an LLC was treated
as a limited partner if the individual did not make management decisions concerning
the LLC’s business; the LLC could have been formed as a limited partnership in
the same jurisdiction; and the member could have qualified as a limited partner in
the limited partnership.


http://www.ciremagazine.com/article.php?article_id=464