Will the IRS impute LLC members with self-employment tax?

On Behalf of | Oct 31, 2016 | Tax Controversies

In last week’s post, we talked about new tax rules that may increase the risk of audits to general partnerships. Yet the tax obligations of LLC members may also be confusing. 

According to one commentator, many LLC members are still confused about whether provisions of Section 1451 and 1452 of the Internal Revenue Code’s self-employment tax rules apply to them. Said another way, LLC members may be unsure whether they may have self-employment tax liability arising from the LLC’s earnings.

The confusion can be traced back to the legislative history: When Section 1452 was added to the Tax Code in 1977, LLCs did not yet exist as a business form. Consequently, the language in Section 1452 describes conventional partnership forms, including limited partnerships, but not LLCs. Section 1452 clearly states that a general partner’s distributive share of the partnership’s income is subject to self-employment income tax.

Unfortunately, a recent IRS publication suggests that the agency plans to aggressively pursue self-employment taxes from some kinds of LLC members. According to that informal authority, the IRS will evaluate the contributions of an LLC member to the business. If the LLC member functioned as a manager, the member’s share of income may be subject to self-employment tax.

Our law firm has helped many clients involved in tax controversies or disputes with the IRS. We strongly believe that it is the obligation of the IRS to set forth clear tax rules. Otherwise, taxpayers cannot understand their tax obligations under the law. At the very least, tax penalties should not be imposed for obligations that are not clearly defined in the Tax Code. Without an attorney’s help, the self-employment tax rules for LLC members could be a confusing section of the Tax Code.

Source: Forbes, “IRS Grows Increasingly Aggressive In Subjecting Income Of LLC Member To Self-Employment Tax,” Tony Nitti, Oct. 3, 2016