self employment income for limited partner

[JoshinNC]

That is my position

So if we state in our operating agreement that no guaranteed payments will be made, then none of the LLC members will have to pay any SE tax because all is distributive shares of the profit?

And I have yet to see a case where it failed. Until the proposed regs are law, or there is something done about this, my more aggressive clients will continue to take pay little, if any, SE tax.

[wayne]

self employment income for limited partner

thanks to all of you for your valued opinions. I will do more research on this subject and weigh the opinions you provided. thanks!

[OldJack]

So then, pick and choose. Just be ready if IRS sends notice and asks why no schedule se's were filed with members' returns.

So has ANYONE ever got a notice from the IRS that SE tax should have been calculated on income of any variation of LLC entity?

[ChEAr$]

SE tax

There are two schools of thought on this subject, and sadly IRS has not addressed the issue.
Nor have tax people come to an acceptable agreement among themselves.

On one hand, people will aver that SE tax does NOT attach to LLC members, even though they are filing a 1065 or a schedule c.

On the other hand, most people I know agree that if a 1065 or schedule c is filed, then
SE tax is to be calculated, meaning in your client's case all profits would be subject.

So then, pick and choose. Just be ready if IRS sends notice and asks why no schedule se's were filed with members' returns.

[RJM]

Thanks Brad

I am going to read those proposed regs today.....-Bob

[Brad Imsdahl]

Don't blame IRS. The DID come out with proposed regulations [Proposed Reg. Section 1.1402(a)-2(h)] in January of 1998 giving specifics on when it is subject to SE tax and when it is not.

Six months later, the Republican Congress, egged on by the ranting and ravings of Rush Limbaugh, told IRS to back off putting the proposed regs on hold, and nothing has been done since.

BTW, IRS still considers the proposed regs valid, even though the law passed in July of 1998 made them invalid.

[RJM]

I think that Congress and the IRS deserve to lose the revenue, because they have avoided making definitive rules on the issue for many years. So although I always advise my (few) LLC clients to be reasonable and treat themselves as General Partners, I also explain the "no rule about LLC SE tax issue" and let them decide how to treat the issue, with warnings about audit costs, etc. But despite my advice, I know that probably 95%+ of all LLC filers who do not pay SE tax will never be audited.

Am not sure why Congress and the IRS have avoided making rules about this, but I think it is related to the "reasonable compensation" issue. They still need to decide where to dig in on the issue, but I think they are trying to evaluate all the revenue implications of any particular decision, and this is taking lots of time.

[Jesse]

but something got lost in the translation.



Original subject spoke about a limited partner. However LLC's have members, not partners.
Confusion arises because default tax treatment is partnership. Anyway, look to the
operating agreement for direction on "guaranteed payments" issue and proceed
accordingly. Of course members may get together and rectify a situation by amending
the agreement later.

So if we state in our operating agreement that no guaranteed payments will be made, then none of the LLC members will have to pay any SE tax because all is distributive shares of the profit?

[ChEAr$]

I know what everybody's saying of course,

but something got lost in the translation.

LLC started a new business in 2006. had net profits of approximately $80,000. neither partner received a guarenteed payment. how much of the net profit is subject to SE tax and what amount is considered a distributive share of profits.

Original subject spoke about a limited partner. However LLC's have members, not partners.
Confusion arises because default tax treatment is partnership. Anyway, look to the
operating agreement for direction on "guaranteed payments" issue and proceed
accordingly. Of course members may get together and rectify a situation by amending
the agreement later.

[New York Enrolled Agent]

I believe Proposed Regulation §1.1402(a)-2 was an attempt to address some of this. This would show the IRS thinking & while the reg has not moved forward, it would appear the overly aggressive position of no S/E tax would be a real tough battle.

[Brad Imsdahl]

But isn't a limited partner presumed not to have matrially particated in the activity?

No, not at all. Section 1402(a)(13) says a limited partner's distributive share of income is not subject to SE tax. Then it says, "other than guaranteed payments...to that partner for services actually rendered to or on behalf of the partnership..."

So there is no requirement in the code that a limited partner cannot perform services for the partnership. It simply states that if that limited partner does perform services, then the guaranteed payments are subject to SE tax.

[Jesse]

Thinking out loud.........

Just not SE tax. There is NOWHERE in the code that requires that a taxpayer who is a limited partner take GP. If the taxpayer is smart enough to not write wording into the operating agreement that specifies these types of payments I don't see a leg for the IRS to stand on.

I struggle with the LLC's and SE issue so I'm just thinking out loud:

But isn't a limited partner presumed not to have matrially particated in the activity?

In the LLC that you and your partner are operating you are materially participating so even if specified in the operating agreement that you are a limited partner doesn't make it legite, or does it?

If a reasonable amount is not taken for your work in the LLC I would think the IRS does have a leg to stand on.

[Brad Imsdahl]

Just not SE tax. There is NOWHERE in the code that requires that a taxpayer who is a limited partner take GP. If the taxpayer is smart enough to not write wording into the operating agreement that specifies these types of payments I don't see a leg for the IRS to stand on.

There is also nowhere in the code that says an LLC member is a limited partner. I guess that means the IRS and the courts could interpret that to mean all LLC member income is subject to SE tax under general partnership rules.

Under what grounds do you say the LLC member is a limited partner? If the LLC member is a limited partner, as limited partners are currently defined in the code and regs, then under Reg. Section 1.448-1T(b), no LLC can use the cash accounting method, as any partnership allocating at least 35% of losses to limited partners is defined as a tax shelter.

Tax shelters are not allowed to use the cash method.

Now is it your opinion that LLC members are limited partners?

[JoshinNC]

It's ALL subject to tax

Just not SE tax. There is NOWHERE in the code that requires that a taxpayer who is a limited partner take GP. If the taxpayer is smart enough to not write wording into the operating agreement that specifies these types of payments I don't see a leg for the IRS to stand on.

[Brad Imsdahl]

to making these types of decisions. If my client is inherently very conservative I won't even bring it up. But, if they want to take all legal (as you say, no court cases to prove otherwise) steps to avoid SE, we jump on it.

Then be prepared to take it to court.

Until there is a court precedent, there is no right or wrong answer.

Having said that, tax seminars that I have attended indicate IRS audits on the LLC SE tax issue are currently operating similar to the S corp wage issue. Rather than go to court, IRS and taxpayer reps are compromising on the reasonable comp issue. I would definitely not advise trying to get away with zero guaranteed payments. Auditors are currently taking an aggressive approach, and the compromises are learning more towards the Social Security maximum wage base, rather than next to zero.

If you want to be the first test subject in tax court, go ahead. But no IRS auditor is going to back down from the stand that at least something needs to be subject to SE tax.