S/E tax on distributive share of income for partners of LLC'S and non-LLC.

[Armando Beaujolais]

There is no more of a gray area with LLC members taking guaranteed payments than there is with limited partners taking guaranteed payments.

The conflict with the law and regulations is specific to distributive share. At the time that guaranteed payments for services are determined, the distributive share does not even exist.

Compensation for services is SE or payroll taxable, whether it's LLC members or partners or S corporation shareholders. It's no different from an S corporation. Compensation for services is wages. Yes, lots of people take lots of distributive share of income from S corporations as not subject to SE, but they're saying that the earnings were corporation earnings and not compensation for services.

You're saying that because SE treatment of distributive share is a gray area, that gray area also extends back in time to when services were performed and compensation for services was established.

The gray area with LLC earnings is specific to distributive share, it's not a wild card you can lay down to cover any issue you want.

[OldJack]

The gray area with LLC earnings is specific to distributive share, it's not a wild card you can lay down to cover any issue you want.

Armando, I am not in disagreement with anything you said, however, how about addressing the reality of this situation and tell us what you as the tax preparer would do:

Facts: LLC-1065 50% owners. LLC earnings for the year is $200,000.00. All members worked full time equal hours in the business and members have previously agreed they will take no pay for services provided to the business. Each member receives $50,000 cash distributions for a total of $100,000.

Armando, you are engaged to prepare the form 1065 and related 1065-k1 (if you accept the assignment). As you say this is not a gray area, what amounts on the K1, if any, do you show as guaranteed payments (box 4) subject to SE tax and how much of the earnings, if any, are shown as subject to SE tax (box 14)?

[Bees Knees]

Armando, you are engaged to prepare the form 1065 and related 1065-k1 (if you accept the assignment). As you say this is not a gray area, what amounts on the K1, if any, do you show as guaranteed payments (box 4) subject to SE tax and how much of the earnings, if any, are shown as subject to SE tax (box 14)?

Guaranteed payments are defined under Section 707(c) as amounts "determined without regard to the income of the partnership..."

In other words, to be considered a guaranteed payment, it has to be determined ahead of time. Such as I agree to work for $30 per hour, or $7,000 per month, or 45% commission, etc. etc.

The minute you say we made $200,000 this year, so lets take a $100,000 distribution because of all of our hard work, it is no longer a guaranteed payment because it is based on profits, not work.

There is no law that says a partner MUST receive guaranteed payments for services performed. Partners CAN agree to work simply for their distributive ownership share of profits. It is when you base the calculation of the payment without regard to the profits of the partnership that the code requires it to be a guaranteed payment.

[OldJack]

Bees, I agree with everything you said. Now.. how would you fill out the boxes on the 1065-k1. Box 1-ordinary income, box 4-guaranteed payments, and box 14 code "C" self-employment earnings?

[JON]

IRS has a position.

The regulations did not get passed, but IRS has used the same criteria before as after. Two attorney start up operation had a couple part time receptions that came is as needed. They had decided how and what the draws, guarantees, would be. There was good reason for that as one initially was working more hours than the other. It was an LLC with 50/50 split. One of the two attorneys was audited on the 1040 and they expanded to include the 1065 as part of the audit. The 1065 was the second, first full year, of operation. It was a simple return and no changes. The way the year finished on partner had guarantees a lot more than the other. The bottom line "net" which was split 50/50 was only. SE was calculatede on the guarantee payments only. This is two years ago. I had a long conversation with the agent on the SE issue. I am not going to be able to remember the quotes exactely. The IRS position is if you are working/performing services there needs to be SE tax. If there is no performance by the member he admitted there probably would be very little reason to assign SE. In my case he did not really like the 50/50 being ignored, but probably passed on it because he did not think it was material. I asked why there had not been any cases. He said who argues if amounts are small. Rather than continue I am going to see if this posts. I started it about 50 minutes ago. I have been interupted a bunch I times and even I do not understand my ramblings. I am sure all of you will.

[Bees Knees]

Bees, I agree with everything you said. Now.. how would you fill out the boxes on the 1065-k1. Box 1-ordinary income, box 4-guaranteed payments, and box 14 code "C" self-employment earnings?

Your example said "members have previously agreed they will take no pay for services provided to the business." Therefore, there was no agreement ahead of time that any partner (or member if you prefer) would get any distribution if the operation were not profitable. Each partner agrees to perform services in exchange for their ownership interest and any distributive share of profits that may result."

Under those set of facts, line 1, K-1 will equal $100,000 for each partner, line 4, K-1 guaranteed payments will equal zero, and line 14 code "C" self-employment earnings will equal zero, since this is an LLC. If it were not an LLC, or if members are personally liable for all LLC debt, then line 14 code "C" would equal $100,000 for each partner.

The IRS may not like it, but those are the rules as they currently stand. Until Congress changes these rules, or IRS issues a new set of regs, the line 1, K-1 profits are not subject to SE tax, and no amount can be allocated to guaranteed payments because each member agreed to potentially work for free if the company made no profit for the year, and no deferred compensation agreement was in place.

[OldJack]

You are correct that the IRS may not like it. Here is their current publication from their website:

Self-Employment Taxes

1. LLCs filing Schedule C or E
Members are subject to
self-employment taxes on earnings.

2. LLCs filing Partnership Returns
Generally, members pay
self-employment tax on their share
of partnership earnings.
There is a special rule for members
who are the equivalent of limited
partners. They pay self-employment
tax only if the LLC pays them for
services.

[Bees Knees]

You are correct that the IRS may not like it. Here is their current publication from their website:

Their publication is based on IRS Regs issued in January of 1997 [Proposed Reg. Section 1.1402(a)-2(h)]. Congress repealed those regs later that summer under Section 935 of the Taxpayer Relief Act of 1997.

Interesting that all IRS had to do is re-issue those same regs and they would be effective today.

Why has IRS not done so? Why has IRS never challenged an LLC on the SE tax issue in court?

You keep citing over and over again the pubs that reflect this out dated proposed reg as having authority. It is kind of like propaganda. If you say it over and over again, pretty soon people start to believe it as fact.