self employment tax and LLC

[JoshinNC]

No, I don't agree

I really didn't mean to stir up a can of worms. It is a H & W LLC providing security services. Only H works and gets a W-2. W only does books and banking and does not take salary. All taxes withheld on that part. This is his main employment. LLC started 2005 and I cannot find where an election was ever made and in fact 1065 has always been filed and as best I can see his income was always on a w-2 and subtracted from the gross on the 1065. What to do??? I would think that since this is a 50/50 ownership, I would pay se on his part and not on her part. Agree??

But you do what you feel comfortable with doing.

[Burke]

I do agree with the OP. (It seems we just had this conversation recently in another thread where all positions on the matter were thoroughly examined, cites discussed, regs thrashed and disposed of, and we parted ways agreeing to respectively disagree.) Since Congress can't seem to agree either, I guess we are left to the courts to decide in a subsequent relevant case. I thought of the QJV issue as well, but JoshInNC is correct. Since it is an LLC, can't use. The partnership can use a different percentage for ownership, profits and liabilities, can it not?

[Bees Knees]

this case did involve lawyers performing personal services (legal services) for the law firm, and for a LLP (not an LLC). It was a flimsy argument that lawyers that derive nearly all of their income from services could exclude their "limited partner" source of income distribution from SE earnings. Still, I think that the proposed reg may work in the case of a husband and wife owned business where the wife has little or no active participation.

1) Most of our LLC clients perform all of the work, just like the lawyers in the Renkemeyer case. So unless you are claiming your LLC members are just investors in the business and do not perform services, according to this court case they are subject to SE tax, regardless of their limited liability status.

2) An LLP gives the partners the same limited liability status of that of an LLC or a corporation. Thus, you can't ignore the case and say that only applies to LLPs.

3) The court said nothing about the 500 hour active participation rule for passive activities. It used active participation to mean in contrast to just being an investor with no substantial services being performed. Thus, the IRS regs really have no bearing on the outcome of this court case.

What is interesting is what the court said: "Congress intended Section 1402(a)(13) to apply to investors who were not actively participating in the partnership."

That is a HUGE statement, because it contradicts the very reason why the LLC members are claiming they are not subject to SE tax - the fact that they are limited partners due to their liability protection under state law. The court says liability protection has nothing to do with code Section 1402. The court says Section 1402 was written because limited partners are usually investors that do not participate in management.

I can see this case being argued again and again in future cases where LLC members try to claim they are not subject to SE tax due to their limited liability status. If other courts follow this case, that argument won't be valid anymore.

[DaveinTexas]

Bees

1) Most of our LLC clients perform all of the work, just like the lawyers in the Renkemeyer case. So unless you are claiming your LLC members are just investors in the business and do not perform services, according to this court case they are subject to SE tax, regardless of their limited liability status.

2) An LLP gives the partners the same limited liability status of that of an LLC or a corporation. Thus, you can't ignore the case and say that only applies to LLPs.

3) The court said nothing about the 500 hour active participation rule for passive activities. It used active participation to mean in contrast to just being an investor with no substantial services being performed. Thus, the IRS regs really have no bearing on the outcome of this court case.

What is interesting is what the court said: "Congress intended Section 1402(a)(13) to apply to investors who were not actively participating in the partnership."

That is a HUGE statement, because it contradicts the very reason why the LLC members are claiming they are not subject to SE tax - the fact that they are limited partners due to their liability protection under state law. The court says liability protection has nothing to do with code Section 1402. The court says Section 1402 was written because limited partners are usually investors that do not participate in management.

I can see this case being argued again and again in future cases where LLC members try to claim they are not subject to SE tax due to their limited liability status. If other courts follow this case, that argument won't be valid anymore.

I understand completely. One suggestion on another forum was to pay each member their respectively reasonable salaries (guaranteed payments) and then the remaining profits (distributive shares of profit) would not be subject to SE tax, just taxed as ordinary income; very similar to an S Corporation. Do you think the IRS would have a problem with that stance?

[Burke]

I understand completely. One suggestion on another forum was to pay each member their respectively reasonable salaries (guaranteed payments) and then the remaining profits (distributive shares of profit) would not be subject to SE tax, just taxed as ordinary income; very similar to an S Corporation. Do you think the IRS would have a problem with that stance?

Probably. They are always going to decide in their favor and not the taxpayer's when there is a differentiation in interpretation. But this is exactly the type of case we need to go to Tax Court.

[Bees Knees]

I understand completely. One suggestion on another forum was to pay each member their respectively reasonable salaries (guaranteed payments) and then the remaining profits (distributive shares of profit) would not be subject to SE tax, just taxed as ordinary income; very similar to an S Corporation. Do you think the IRS would have a problem with that stance?

That is the view I have held for many years, and seems reasonable. However, a tax seminar speaker who has extensive experience with S corporation audits said the IRS is looking for the owners to receive the maximum wage that is subject to the Social Security tax portion of FICA. So reasonable wage to IRS means paying maximum Social Security tax. If you are going to take the same approach with LLCs, then max Social Security is what IRS would be looking for.

I don't necessarily agree with that. I think reasonable wage means what other non-owner employees receive for doing the same type of work.

[Gary2]

That is the view I have held for many years, and seems reasonable. However, a tax seminar speaker who has extensive experience with S corporation audits said the IRS is looking for the owners to receive the maximum wage that is subject to the Social Security tax portion of FICA. So reasonable wage to IRS means paying maximum Social Security tax. If you are going to take the same approach with LLCs, then max Social Security is what IRS would be looking for.

I don't necessarily agree with that. I think reasonable wage means what other non-owner employees receive for doing the same type of work.

That may be what they're looking for on an audit, but S Corps have a long history of being able to claim reasonable wages on a W-2 with reasonable non-FICA/SECA pass-through income, viewed as ROI, reported on the K-1. This is one of the main advantages of S-Corps over partnerships. I've never heard of them insisting that salaries must be at the highest end of reasonable, unless it's because none of the income could be attributed to either capital or non-shareholder employees - but perhaps they never let such cases get to trial, or my readings are too limited.

Partnerships have always been different, in that general partners have to treat their entire distributive share as subject to SE tax. Hence, ages ago, Congress used the liability distinction between general and limited partners to distinguish between SECA and non-SECA income. Then states introduce LLPs and LLCs, and all of a sudden, people in the roles of general partners get the benefit of limited liability, and Congress's distinction no longer achieves its intent. If you go with the original intent (or what I'm assuming, dangerously, was their intent), then it makes perfect sense that anyone in an LLC who fits all the characteristics of a traditional general partner except for liability would have to pay SE tax on their full distributive share plus guaranteed payments. If they want the benefit of excluding income from SE tax, they should choose S-Corp treatment.

This makes me wonder: Prior to the introduction of LLPs and LLCs, to what extent did state law prohibit limited partners from participating in the work of the partnership in order to maintain their limited liability protection.