SE tax on LLC distributable income and guaranteed payments.

• Author: Hawkins, Richard L.
• Position: Self employment, limited liability companies

The self-employment (SE) tax rules oil distributable limited liability company (LLC) trade or business income and guaranteed payments are an everyday issue in tax practice, but there is little guidance on determining the income subject to SE tax.

The SE tax rate is 15.3%, of which 12.4% is Old Age, Survivors, and Disability Insurance (OASDI), and 2.9% is Medicare tax. The OASDI portion is subject to an $87,900 limit for 2004. The Medicare tax is not subject to an income limit and, thus, is paid on all SE net earnings. One-half of the SE tax can be deducted in arriving at adjusted gross income. Another deduction is allowed through the SE tax computation itself; SE income is reduced by 7.65% before calculating the tax.

Determining SE Taxable Income

Sec. 1402(a) defines "net earnings from SE" to include an individual's distributive share (whether or not distributed) of income or loss from any trade or business carried on by a partnership in which he or she is a member. A partner's share of partnership dividends, interest and certain gains and losses are excluded by Sec. 1402(a)(2), even though they arise from the operation of a trade or business. Nontrade or business income (e.g., real estate rentals) is also excludible, via Sec. 1402(a)(1).

Sec. 1402(a)(13) excludes from SE income a limited partner's distributive share of any income or loss, other than guaranteed payments received for services actually rendered. While a general partner's distributive share of trade or business income is subject to SE tax, a limited partner's share is not. However, if a limited partner receives a guaranteed payment for services actually rendered to or on the partnership's behalf, such payment is SE income; see Regs. Sec. 1.1402(a)-1(b).

While LLCs are subject to the partnership taxation rules under the default provisions of the "check the box" regulations, LLC members are not general partners; thus, trying to classify them as such for tax purposes can be confusing. As BNA Tax Management Portfolio 7252d, Limited Liability Companies, p. A-31, succinctly states," [u]nfortunately, little guidance exists regarding classification of LLC members as general or limited partners. Due to the failure to address the treatment of members as limited or general partners, application of the Code to LLCs produces anomalous and uncertain results."

In 1994, Treasury issued proposed regulations (Prop. Regs. Sec. 1.1402(a)18; EE-45-94, 12/28/94) dealing with the SE taxation of LLC...