I can’t believe I’m saying this, especially since the federal government is issuing regulations at the rate of about 10 each day (somewhere between 2,200 and 4,500 annually), according to the National Research Service! But there’s one area in which regulations are long overdue and I would welcome them: IRS guidance on self-employment taxes for members of limited liability companies.
It’s been nearly 17 years since the moratorium on the IRS’s issuing regulations expired (on June 30, 1998). In all this time, there has been very little guidance on how LLC members should figure their self-employment tax. There were, of course, regulations that were proposed in 1997, had guidance for determining whether LLC members should pay self-employment tax on all of their distributive share; these proposed regulations have never been adopted.
Here’s the problem:
General partners in partnerships pay self-employment tax on their distributive share of partnership income, without regard to the size of their ownership interest (i.e., whether they have a majority or minority interest) or whether they actively participate in the business. In contrast, limited partners in a partnership do not pay self-employment tax on their distributive share (by definition, limited partners don’t participate in the day-to-day operations of the business). So why are LLC members, whose share of LLC income is reported on the same Schedule K-1 as used for partners, treated as general partners or limited partners for self-employment tax purposes?
Last year, the IRS clearly indicated that it would issue regulations under Code Section §1402(a)(13) (look at item number 16 in the section for executive compensation, health care and other benefits, and self-employment tax in the IRS Priority Guidance 2014-2015.
That Code Section says:
“there shall be excluded the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described in section 707(c) to that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services.”
Currently, the consensus among advisors is that LLC clients who are merely “silent investors” (like limited partners) do not owe self-employment tax. If LLC members are at the other end of the spectrum in terms of participating in the LLC’s activities by managing its daily affairs, they are more like general partners and are likely subject to self-employment tax. What is tricky is providing advice for those who fall in the middle, acting as mere investors sometimes but participating in business activities at other times.
While the 2014-2015 priority guidance season hasn’t ended this year, it is nearing a close (it ends this June). Where are these promised regulations?