LLC members SE tax

[Soleyme]

I am hoping someone has found more guidance than I have on whether a limited member is subject to self employment tax as an LLC member. I have found proposed guidance on the IRS website that suggests all LLC members in a business that provides services are subject to SE tax and a few court cases that seem to contradict each other. One case in which the IRS took the position that a limited "partner" in an LLC could not take a loss against his income but rather should have taken the loss as a passive activity. However, another case the IRS took the position that there is no such thing as a limited partner in the LLC entity and the member that was considered limited should have paid SE tax on the income from the LLC.
Under Section 1402(a)(13) a limited partners share of the limited partnerships income is excluded from Self Employment income.

Here is my situation...I filed a partnership return for their first time in 2013 for Taxpayer A and Taxpayer B (husband and wife, respectively) who are the only 2 members of the Pennsylvania LLC in which they offer consulting services. Taxpayer B does all of the work and is the LLC member-manager for sure. She is subject to SE tax. However, taxpayer A has a full time job otherwise and does not participate in the LLC but is listed as the second member. They both have 50% ownership. While there are no liabilities on the books, Taxpayer A would be subject to paying them back, I believe, due to the marriage. So.....is Taxpayer A subject to Self Employment tax on his 50% share of the net earnings?
Thanks so much for everyone that can help.

[kathyc2]

I think this is a grey area and is based on a judgment call based on details on individual case in the same line as reasonable compensation in a S-corp.

If it was me these are some of the things I would take under consideration:
1) Bearing in mind the purpose of not having income subject to SE if investment, how does the ratio work out? If husbands investment was 5K and his share of profits is 50K, it would be difficult to justify this is a reasonable case this is return on investment.
2) If the business was taxed as an S-corp would the wife's 50% meet your criteria as reasonable compensation?
3) Assuming being a consulting business that the initial outlay was low (would not need a lot of equipment). Also, no mention of employees, so I'm assuming the income generated is almost exclusively from wife's time, knowledge and efforts and therefore most if not all should be subject to SE.
4) Consider having the majority of income to wife as guaranteed payments with the leftover profits of wife subject to SE and husbands share not subject to SE assuming he did not actively participate in business.

[Gretel]

Here are my 2 cents. In a services business with no employees and no inventory it is hard to justify that any income generated is not subject to SE. A main factor to look at is what would an employee be paid if he had all the responsibility and did all the work. Only was is above and beyond this amount can be considered as non SE.

In my State only professionals can be in a professional LLC. Why does this LLC even have a partner that does not work?

[kathyc2]

Why does this LLC even have a partner that does not work?

There is a train of thought that 1065 returns are less likely to be audited than Schedule C. A single member LLC can not be taxed as a partnership, only Schedule C or corp which has additional paperwork requirements as payroll is required.

[Gretel]

Let me be a little clearer: We are talking about a professional LLC not a LLC in general. In my State it is illegal to have a non professional be part of a professional LLC. Of course we do not know if non-working member is a professional or not and I do not know the rules if there could be a non-working member that is a professional.

[Soleyme]

Thank you

I think this is a grey area and is based on a judgment call based on details on individual case in the same line as reasonable compensation in a S-corp.

If it was me these are some of the things I would take under consideration:
1) Bearing in mind the purpose of not having income subject to SE if investment, how does the ratio work out? If husbands investment was 5K and his share of profits is 50K, it would be difficult to justify this is a reasonable case this is return on investment.
2) If the business was taxed as an S-corp would the wife's 50% meet your criteria as reasonable compensation?
3) Assuming being a consulting business that the initial outlay was low (would not need a lot of equipment). Also, no mention of employees, so I'm assuming the income generated is almost exclusively from wife's time, knowledge and efforts and therefore most if not all should be subject to SE.
4) Consider having the majority of income to wife as guaranteed payments with the leftover profits of wife subject to SE and husbands share not subject to SE assuming he did not actively participate in business.

Thanks for the thoughts. I hadn't considered guaranteed payments to her. Currently, I have allocated 50/50 as per the silent agreement and all subject to SE tax. However, since the husband has another job, he hits the max for SE earnings and therefore his portion is only taxed at the additional 2.9%. Thus, it saves alot of money on self employment taxes.

[Soleyme]

Thank you

Here are my 2 cents. In a services business with no employees and no inventory it is hard to justify that any income generated is not subject to SE. A main factor to look at is what would an employee be paid if he had all the responsibility and did all the work. Only was is above and beyond this amount can be considered as non SE.

In my State only professionals can be in a professional LLC. Why does this LLC even have a partner that does not work?

Thanks for the response. The taxpayer filled out and filed her own LLC paperwork and put her husband on as her partner.

[Soleyme]

Professional LLC

Let me be a little clearer: We are talking about a professional LLC not a LLC in general. In my State it is illegal to have a non professional be part of a professional LLC. Of course we do not know if non-working member is a professional or not and I do not know the rules if there could be a non-working member that is a professional.

In PA, we have a "general" LLC and a "restricted" LLC whereas the restricted LLC's are specific to Chiropractic, denistry, law, medicine, optometry, accounting .....etc. Her consulting business does not fall into a restricted LLC so she is organized as a general LLC.