Discussion:Just Want to Verify?
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Discussion Forum Index --> Tax Questions --> Just Want to Verify?
| 22 February 2010 | |
| We are doing a partnership return which was prepared by a CPA firm in prior years. We can't figure out why that firm only included guaranteed payments subject to self employment taxes. They did not include any of the ordinary income amount for self employment purposes. For example partner shows 5000 in guaranteed payment and 12000 or so in ordinary income. Prior firm only included the 5000 on Sch. SE.
These are not passive investors. Basically both are active in a welding, sheet metal type of business. Just want to make sure we're not crazy in including ordinary income also. Can you think of any reason they would only include the guaranteed payment amount for SE purposes. | |
| 22 February 2010 | |
| Was the partner a limited partner? See Sec. 1402(a)(13). Was the entity an LLC or an LLP? | |
| 22 February 2010 | |
| Thanks .. It was a general partnership. It was an LLC entity taxed as a partnership. | |
| 22 February 2010 | |
| Sound like the CPA firm was relying on IRS arguments that an LLC interest is the same as a limited partnership interest. The same arguments the IRS used in Garnett and Thompson. And in an efort to avoid being piggish, recharacterized some earnings as subject to SEtax through guaranteed payments. | |
| 22 February 2010 | |
| More likely, it sounds like the CPA firm was following the example involving an LLC in Prop. Reg. §1.1402(a)-2(i). | |
| 23 February 2010 | |
| Thanks .. Have now printed out and read the above Reg. and as usual am not sure at all just what in the heck they are saying.
Is this typical (pretty common) of an LLC taxed as a partnership to not include partnership earnings in or for SE tax. Or is this some kind of way out to avoid SE taxes. If indeed you treat a partner as a limited partner and not subject earnings to SE tax would you still check the box indicating that they are a General Partner. This is all new to me. | |
| 23 February 2010 | |
| What does your State's LLC law require? Some states allow all members of a LLC to be limited. Others do not. LLCs are disregarding entities filing on a 1065 form. | |
| 23 February 2010 | |
| I've read the stuff (Regs / other material) a little more closely and find it makes little sense. Or at least seems to be more complicated and unclear than it should be. From what little I could understand, it does not sound to me like 3 guys that form a partnership (LLC) and all 3 work full time in the business can or should be able to avoid paying SE tax on the earnings from the partnership and only pay on some amount attributed as guaranteed payments.
I thought people went this LLC route basically to help with or get similar liabilty protection as one gets under a corporate veil. Those of you that do a lot of partnership returns what do you see in this area and or how do you look at or treat the partnership earnings. Have you ever taken that route as treating some active partners as limited partners thereby not allocating their share of earnings to SE tax. | |
| 23 February 2010 | |
| Remember that the proposed regulations do not hold the force of law. Basically, you are left to your own imagination to determine whether your clients are truly limited partners. | |
Heritage120 (talk|edits) said: | 23 February 2010 |
If all 3 are working full-time in the business then it is more likely they are active partners and subject to SE tax on their share of the income/(Loss) for the year. I prepare my fair share of Form 1065's and most fall into that type of tax treatment. This is all about interpretation. I have done Ptnshp returns where you have 1 general manager who works in the business & other partners live in other cities or states. They do not participate in the running of the business nor do they work. It would be ok to apportion the general mgr's portion of the Profit subject to SE tax. Other partners are passive. I would not subject them to the SE tax.
Guaranateed Payments + share of profit/(loss) is subject to SE tax. | |
| 23 February 2010 | |
| Actually if a "passive" partner has income from a "trade or business" conducted by the "general" partnership, that income is subject to SEtax. Ddoshan has introduced the concept of an LLC that has members that may or may not be considered "limited" partners. Section 1402(a)(13) specifically exempts "limiited" partners share of partnership profits from the SEtax. As Riley states, "Basically, you are left to your own imagination to determine whether your clients are truly limited partners."
A reading of other posts, the Proposed reg DaveFogel alluded to (Andrew Mitchell has a nice picture of this), Proposed Reg reg 1.1402(a)-2(h), and recent tax cases (which are actually about passive activities but speak of the nature of the LLC member) will show there is no correct answer to the applicability of the SEtx to LLC members. I think. | |
| 23 February 2010 | |
| MWPXYZ, the Tax Court held in Garnett v. Commissioner, 132 T.C. No. 19 (2009), that the membership interest in the LLC and the partnership interest in the LLP (limited liability partnership) were more akin to general partnership interests in a limited partnership, and therefore, did not constitute limited partnership interests for purposes of IRC §469(h)(2). If the same decision were applied for SE tax purposes, then the result would be that the distributive share of income to the LLC member and the LLP partner would be treated as net earnings from self-employment.
As a result, I think that practitioners have a choice when faced with classifying the distributive share of income from an LLC. They can either (1) follow the Garnett case and treat the entire distributive share of income as SE income, or (2) follow the proposed regulations. Even though the proposed regulations do not have the force of law, the IRS is not likely to disagree with its own proposed regulations. | |
| 24 February 2010 | |
| Without getting into it too deeply, at this time (its busy, drifting from original post and there are several other posts on this), it seems that there may be more than 2 options.
First of all the available regs are “merely” Proposed Regs (from 1997 that have not gone beyond being proposed”) that give an idea of the IRS POV on the subject. And Garnett etc while disagreeing with the IRS definition of limited partner under the passive loss rules did not address the definition of limited partner under the SEtax rules. Having said that however, it seems the court is willing to delve into state LLC statutes to come up with the “correct” definition of limited partner for passive (and SEtax rules?). Could the IRS accept defeat in Garnett etc and assess all LLC partners with SEtaxes. An exemption from SEtax on earnings from a trade or business hinges on one paragraph for limited partners. On the other hand the proposed regs for SEtax does address LLCs specifically. On the other hand they are “merely” proposed regs, etc. I probably haven’t explained it well, but I am not sure that an LLC member can be certain of their status regarding the Setax. | |
