If you are a member of a limited liability company (LLC), do you have to pay self-employment tax? That's a pretty good question.
The self-employment (SE) tax provisions of our favorite Internal Revenue Code were enacted long before the existence of limited liability companies. As LLCs become increasingly popular, an important question arises: how to apply the SE tax rules for LLC members, called LLC owners. Despite the IRS trying to get rid of it, that question still exists for LLCs with several members, which we will call Multi-member LLC. Here is the complex story of SE tax for LLC members.
Individual members of ‘Neglected' Single-Member LLC (SMLLC) have hooks for SE tax
Before resolving the SE tax issue for members of a multi-member LLC, let us quickly resolve the issue for a single-member LLC (SMLLC), which means only one owner. The existence of a single-member LLC (SMLC) is usually ignored for the purpose of federal income tax unless you choose to consider it a corporation – which is not often the case. In other words, a so-called Ignored SMLLC Most of the federal income tax you own as an individual is invisible, including the SE tax purpose.
Therefore, when you own a neglected SMLLC that is engaged in a business, you must calculate your SE tax hit schedule in SE, just as a sole proprietor does. So, you have to pay SE tax on any net SE income generated by SMLLC There is no question about it.
Complications regarding SE tax for members of multi-member LLCs
Now it gets interesting. We begin with the fact that members of LLC classified as partners for federal income tax purposes are considered partners for federal income tax purposes. Thus, as a general rule, the same federal income tax rules, including the SE tax rules, which apply to individual partners, also apply to individual LLC members who are considered partners.
To understand the SEO tax issue for LLC members, we need to start with the long lasting special SEO tax rules for limited partners. Under that special rule, a Limited partners Guaranteed payment of SE income only from partnership for services provided in partnership. Guaranteed payment is a payment that is determined regardless of the partnership's income. They are often referred to as “partner pay”. This special SE tax rule for limited partners is beneficial to them because they usually do not receive any guaranteed payment (partner's salary) for the services and so they usually do not have to pay any SE tax on their share of the income of the partnership. Source: Internal Revenue Code Section 1402 (a) (13).
In contrast, a General partner His share of the net income of the partnership from business activity must be included in the SE income. Therefore, ordinary partners are generally required to pay SEO tax on shares of net partnership income. Source: Internal Revenue Code Section 1402 (a).
Special SE tax rules favorable to limited partners were enacted long before the LLC existed. So how do LLC members deal with the SE tax problem? Can they claim that they are limited partners for the purpose of SE tax because they are not personally liable for the debt of the LLC? If the answer is yes, then they can avoid SEO tax without any guaranteed payment. Instead, they can take random SE-tax-free distributions to collect their shares of LLC's cash flow. But is this an effective position? Arguably yes, although the IRS certainly would not agree to an audit.
Lessons on SE Tax History for Limited Partners
In 1994 and 1997, the IRS issued two sets of proposed regulations on SE taxes for limited partners. They both deal with their confidence as they choose to embark on their play activities. For LLC members who are considered partners for the purpose of federal income tax. Commentators like me have criticized the proposed rules for trying to impose new taxes on affected people without the benefit of supporting legislation. Congress has agreed and prohibited the publication of any provisional or final regulations in this regard before 7/1/98. Of course, that date is long overdue, and no one believes that the proposed regulations (which are still in the books) have any validity at this time. No further regulations have been issued in this regard.
What is the rate of self-employment tax?
How hard can an SEO tax hit? Hard! For 2022, the SE tax rate is the first য়ের 147,000 of net SE income of 15.3% (total income from self-employed deductible expenses approved for SE tax purposes), including the net SE income you receive from the LLC.
That 15.3% rate includes:
* 12.4% for social security tax component of SE tax plus
* 2.9% for Medicare tax component.
* Above the $ 147,000 threshold, the Social Security tax component goes away, but the 2.9% Medicare tax continues to rise to a higher SE income level of 3.8% (আপনি 200,000 if you are unmarried or $ 250,000 between you a married joint-filer). There is a “regular” 2.9% Medicare tax at 3.8% and an additional 0.9% Medicare tax on high earners.
Example: Say অংশ 200,000 is part of your net income from a multi-member LLC that runs a business. Multiply that image by .9235. The result is $ 184,700, and that's the amount of net SE income that is subject to SE tax For 2022, your SE tax bill amount will be 23,584. [($147,000 x 12.4%) + ($184,700 x .029%)].
Unfortunately, when calculating your net SE income, you cannot contribute to a self-employed retirement plan, deduct for a portion of your SE tax, or deduct for self-employed health insurance premiums.
It will only deteriorate
Each year, the Social Security tax threshold increases based on an inflation adjustment. Instead, your SE tax bill goes up. Last August, the Social Security Administration released its latest projected ceiling for the coming year.
* 6 156,000 for 2023.
* 2 162,900 for 2024.
* 8 168,600 for 2025.
* $ 173,300 for 2026.
*, 180,600 for 2027.
These numbers are alarming enough, but it's a pretty safe bet that the actual ceiling will be significantly higher due to rising inflation.
Beware of conflicting IRS positions
The IRS takes the position that individual members of a multi-member LLC who are classified as partners for tax purposes must pay SE tax on the shares of the LLC's net business income. In other words, the IRS claims that the limited partner exceptions mentioned above do not apply to LLC members, although they generally have no personal liability for entity loans, such as limited partners.
Meanwhile, the IRS continues to take a completely contradictory position that members of multi-member LLCs that are considered partners for tax purposes must be considered as limited partners for the purpose of enforcing passive activity loss (PAL) rules. The IRS position is based on the fact that LLC members have limited liability for entity loans like limited partners. This is an unfavorable restriction for LLC members, as strict PAL rules apply to limited partners.
Thus, the IRS takes an anti-taxpayer position on the SE tax issue and a completely opposite taxpayer position on the PAL issue. Heads I won. The tail you lose.
What the tax court has said about SE tax
In a 2017 decision, the tax court noted that the code or any regulatory authority does not define the term limited partner for the purpose of limited partner SE tax exceptions. Nonetheless, the Tax Court ruled that in this case the LLC members (taxpayers) were not limited partners in the general meaning of the term and therefore the limited partners were ineligible for the exception. Source: Vincent Castigliola, TC Memo 2017-62.
Taxpayers were attorneys who acted as members of a professional LLC that was classified as a partnership for tax purposes. There was no written LLC operating agreement or any other evidence that the members' ability to manage was limited. In fact, all members participated in the management by jointly deciding on issues such as the distribution of their LLC revenue; Borrowed money; And hiring, dismissal, and employee compensation. All members supervised the associate attorneys and signed the check for the LLC.
The tax court argued that since all members had the same rights and responsibilities, they must all have a common position with their common partners. Therefore, according to the tax court, the taxpayers were ineligible for the limited partner exception and the LLC (excluding the guaranteed payment received by them) was subject to all income SE tax. Taxpayers took the position that their SEO tax was levied on guaranteed payments received from LLCs.
Observations: In Weather of Castigliola In conclusion, the tax court took it upon itself to define the term limited partner for the purpose of qualifying for the limited partner SE tax exception. After so many years, after two failed IRS attempts to issue regulations in this regard, and the reluctance of the IRS to issue any other authoritative guidelines in this regard, it seems doubtful that the tax court had the power to do so unilaterally. As stated earlier and recognized by the tax court, the Internal Revenue Code or any regulation has not done so. And the IRS continues to this day take the position that LLC members should be considered as limited partners for PAL purposes. Therefore, when Weather of Castigliola The decision is certainly not good news for those LLC members who wish to take a position that qualifies for a limited partner exception, a decision that should probably be viewed with a jaundiced eye.
Bottom line, as it is
Not all questions can be answered definitively. The SEO tax question for LLC members is one of them.
In light of this Weather of Castigliola Decision, realizing that as an active LLC member you are aggressive in assuming that you are eligible for limited partner SE tax exemptions. If you are audited and the IRS detects the problem, you may be assessed for tax, interest and penalty refunds. It states that the position is still supported by the statutory language of the SEO tax treatment of limited partners, the position of the IRS that LLC members should be considered as limited partners for PAL purposes and there is no authoritative IRS guideline in this regard. Eligibility of LLC members has been issued till date for limited partner exception. We report. You decide.