Ongoing Intrigue: Self-Employment Tax, Limited Partners, and LLCs

Ongoing Intrigue: Self-Employment Tax, Limited Partners, and LLCs

On so many fronts, understanding federal tax discipline, and complying with its tenets, is a daunting challenge. Taxpayers with the best intentions, and the practitioners who serve them, face frequent 'head scratchers' in their concerted efforts to apply the IRC, regulations, and judicial authority to fact-sensitive situations.

One of the countless problematic fronts is self-employment taxation and the application of IRC § 1402(a)(13) to limited partners.  This Code section discusses limited partner status qualification for income exclusion purposes, but supporting guidance has left question marks: Some have looked askance at the integrity of related proposed regulations issued 17 years ago.  But now, as part of the 2014-2015 joint Treasury-IRS priority guidance plan released on August 26th, a narrower focus on limited liability companies is on the horizon. (See "Treasury to Rethink Self-Employment Tax Exemption for Partners," taxanalysts® Tax Notes Today, August 28, 2014.)

In broad terms, taxpayers and practitioners navigating self-employment taxation waters have been relying for years on a combination of authority and dead reckoning to reach conclusions bearing on compliance. Limited partnership status is not clearly defined in the Internal Revenue Code, and taxpayer reliance on the IRC § 1402(a)(13) exemption is grounded in part on this absence of definition. A fair amount of confusion clouds the issue.

Renkemeyer, Campbell & Weaver, LLP v. Comm'r, 136 T.C. 137 (T.C. 2011) is just one case in point. The Renkemeyer decision informs that reliance on the statutory exemption by limited liability partnership partners is not ironclad. In Renkemeyer, the Tax Court found that the affected taxpayer acted as a general partner of his law firm, and was a general partner under state law, notwithstanding his identity as a limited partner in the firm's documents. A sub-chapter S corporation formed by law firm attorneys was owned by the firm's employee stock ownership plan, to which the vast majority of the firm's income was allocated . The Tax Court held that partners in a law firm, formed as a limited liability partnership, were subject to self-employment tax in view of the legal services the partners provided for compensation, finding also that allocation of income to the ESOP had no substantive economic effect. It may be worth noting that Renkemeyer did not cite other controlling authority, including Kramer v Comm'r, T.C. Memo 2000-84 (2000); Perry v Comm'r, T.C. Memo 1994-215 (1994); or Johnson v Comm'r, T.C. Memo 1990-461 (1990).  

In this landscape, it has been even less clear whether limited liability company members can prudently take advantage of the same exemption. Treasury/IRS plans to dissect this facet of the problem will hopefully help to calm the waters, although practitoners agree that broader treatment is sorely needed and more than well advised. ("Treasury to Rethink Self-Employment Tax Exemption for Partners," taxanalysts® Tax Notes Today, August 28, 2014.)  Adding to the cloak and dagger environment, albeit understandably, the Service isn't showing its cards just now about this aspect of the 2014-2015 priority guidance plan.