Tax Guru – Ker$tetter Letter

This is the latest installment of an ongoing discussion I have been having over the past few years with Ohio CPA Dana Stahl regarding the question of whether LLC members are required to pay the 15.3% self employment tax on their share of the LLC net income. 

 DS:

Mr Guru – I can’t remember if I asked you about this previously.  If so, I apologize for asking again.  Anyway, the new 2004 K-1 has a check box for “general partner/LLC member manager” and another for “limited partner/other LLC member”.  As you know, we’ve discussed repeatedly about the LLC member/SE tax issues, in that those who are Members of a multi-member LLC can opt out of SE tax.  Therefore, how would you recommend we handle which box to check for someone who is actively making a living in an LLC, but not paying the SE tax?  Just go ahead and check the limited partner box?  Let me know.
DS, CPA

Mr Guru – oops, had an additional thought on this.  Is this new set up on the K-1’s just an IRS trick to get LLC Members to start paying SE tax who have previously opted out?  Seems like it to me.
DS, CPA

KMK:

Dana:

Good point about the new descriptions next to the K-1 boxes.  Looking through the IRS’s instructions, they don’t specifically mention any change with LLCs and SE tax; but I think you are right that checking the General Partner box could possibly be used as an admission that the income is subject to SE tax if IRS ever decides to move beyond its current position of having it determined as such voluntarily. 

I think it’s best to stick with the descriptions that they show in the instructions:

It defines general partner as someone who is personally liable for partnership debts.

Limited partners – Members of LLC can be treated as limited partners for certain purposes.  

Since one of the big benefits of LLCs is the protection from personal liability, we can honestly check the limited partner box, which is what I will be doing for those clients who don’t want their LLC income classified as SE.

Kerry