Self-employment tax and LLCs.

• Date: 01 October 2022
• Author: Hunley, Shaun M.

Net income from self-employment is defined in Sec. 1402(a) as net income from any trade or business plus the distributive share (whether or not actually distributed) of income or loss (to the extent a loss is not limited by the basis, passive activity, at-risk, or other rules) from any trade or business carried on by a partnership (including a limited liability company (LLC) classified as a partnership for federal income tax purposes). Rev. Rul. 65-272 provides that items of income and allowable deductions attributable to any trade or business carried on by a partnership that are required to be taken into account separately under Sees. 702(a) (1) through (8), plus any distributive share of partnership income or loss, are considered as realized from a trade or business and used in computing an individual partner's net earnings from self-employment to the extent not otherwise excluded under Sec. 1402(a). This general rule implies that members of an LLC classified as a partnership are subject to self-employment (SE) tax on their share of the LLC's income from a trade or business. However, Sec. 1402(a)(13) provides an exception for limited partners.

Note: Since the existence of a single-member LLC (SMLLC) is disregarded for most federal tax purposes (unless the SMLLC elects to be classified as a corporation), an individual who owns a disregarded SMLLC that is engaged in a business clearly is subject to SE tax on the SMLLC's net income.

Related SE tax issues facing LLCs

Guaranteed payments

Guaranteed payments, whether received for services or for the use of capital, are included in an individual's net earnings subject to SE tax unless they are received from an LLC that is not engaged in a trade or business (Regs. Sec. 1.1402(a)-l(b)). With a few limited exclusions, "trade or business" has the same broad meaning for this purpose as it has in Sec. 162 (Sec. 1402(c); Regs. Sec. 1.1402(c)-l).The exclusions are those set forth in Sees. 1402(c)(1) through (6) and Regs. Sees. 1.1402(c)-2 through -7 (e.g., services performed as an employee covered by Social Security or the Railroad Retirement program, certain services performed as a public official, and certain services performed by ordained ministers and other religious personnel).

Planning tip: A limited partner is subject to SE tax on guaranteed payments only to the extent they are received for services (Sec. 1402(a)(13)).

A member's treatment of a payment for SE tax must be consistent with the...