For quite some time, Ohio CPA Dana Stahl and I have been reviewing and discussing the long running controversy over whether or not income from an LLC is subject to the 15.3% self employment tax on the members’ 1040s.  Dana recently attended an NSA seminar in Baltimore specifically because they had advertised that they would be covering new developments on this issue (“Solution for SE Tax-Finally? This May Not Be What You Want to Hear!").  I asked Dana to pass along what he learned there, which he did in this email.

Subject: NSA Meeting Update

 

Mr Guru - got back today from that NSA seminar in Baltimore.  The LLC/SE issue was covered on Day 2.  The speaker was a fellow named Bob Jennings (RJ) who apparently has extensive experience as a presenter for such seminars.  Anyway, here's a brief summary:

 

1.    After a history of the issue, RJ stated that there really is no immediate answer to whether Members are subject to the SE tax on payments classified as distributions.

 

2.    However, he cited a concern with tax shelters.  Should the LLC experience losses after not paying SE tax for profitable years, the potential exists that the IRS could classify the LLC as a tax shelter subject to Form 8271 filing (Registration as a Tax Shelter).  How?  By saying that an LLC Member is a Limited Partner and not paying SE tax on the LLC profits, in loss years, then, we would be distributing the loss to Limited Partners in effect.  Therefore, if more the 35% of losses are distributed to Limited Partners, then we have in effect a tax shelter rather than an LLC.  By not filing the Form 8271, we'd be subject to a minimum $25,000 fine.  Something to consider, I guess.

 

3.    Finally, the question was raised that couldn't IRS simply reclassify distributions taken from a multi-member LLC as guaranteed payments?  If no money is taken out, I assume there'd be no problem, but most of my LLC Member clients make a living from their LLC businesses, so they do withdraw money.  We've always classified them as distributions, but now I wonder if that was wise.

 

That's about the gist of the session.  Any comments?  As alway, I continue to be concerned about how I've treated the LLC/SE issue pertaining to my clients.

 

Talk to you soon,

DS, CPA

Dana:

Thanks for the info from the seminar.  I'm not familiar with Mr. Jennings; but some of the info you attributed to him makes him sound like a bit of a worry-wart.

1.  It sounds as if they were a bit misleading in their advertisements for this seminar in claiming that they had an answer to the SE question. Saying that it's still up in the air doesn't seem like it's worth the trip.

2.  A few years of losses doesn't make something into a tax shelter requiring registration.  Those rules involve completely different kinds of business ventures and intentions than those our clients are using to operate their for-profit businesses.  It sounds like Mr. Jennings is just grasping for obscure things to worry about that have very little application to the real world.

3.  Same thing.  If we did nothing but worry about the millions of things IRS could possibly do, we would all go nuts.  The status of this issue seems to be the same.  Until Congress enacts a law requiring SE tax on LLC income, IRS seems too nervous to require it by their own regulations.  They were slapped down a few years back when they tried to make LP income subject to Medicare tax; so they are very unlikely to stick their necks out trying to do the same thing with LLCs.

Nothing you said makes me worry about needing to change our approach to treating SE tax as optional for LLC members on both their K-1 income, as well as capital distributions. 

Those are my reactions to what you passed along, for what it's worth.

Kerry

Follow-Up:

I have spoken with Dana on the phone since this email exchange and he assured me that, in spite of not nailing down the LLC-SE tax issue, the seminar was very worthwhile and Bob Jennings was very skilled at presenting the material and had a lot of excellent tips on how professional accountants can avoid lawsuits.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 10/04/2005 03:38:00 PM Send this post: