New equipment leasing LLCs may avoid SE tax.

• Author: Heatley, Warren
• Position: Limited liability companies, self-employment tax

Many construction companies have related equipment leasing limited liability companies (LLCs) whose income may be subject to self-employment (SE) tax unless structured properly.

The IRS has issued Prop. Regs. Sec. 1.1402(a)-2(h)(2) on the SE tax treatment of limited partners in any entity classified as a partnership, including an LLC.

Under the Internal Revenue Code, a limited partner's distributive share of income from a trade or business is excluded from SE tax. The new proposed regulations provide guidance for treating a member of an LLC as a general or limited partner for SE tax purposes.

An LLC member's share of LLC income is not subject to SE tax if the member is considered a limited partner. The proposed regulations provide the following requirements for such treatment.

LLC Requirements

The LLC must not be a service entity, i.e., one that provides health-related, legal, engineering, architectural, accounting, actuarial or consulting services.

Member Requirements

* The member must not have personal liability for the LLCs debts;

* The member must not have authority (under the law of the state in which the LLC is formed) to contract on behalf of the LLC; or

* The member must not participate in the LLC's trade or business for more than 500 hours during the LLC's tax year.

A member may participate for more than 500 hours if there are other members treated as limited partners and they own a substantial part of the entity.

In addition, the ownership interest of all members treated as limited partners must be identical in rights and obligations. The member may not, however, have personal liability or authority to...