Q:

Subject: Self-Employment Tax

Guru,

Much to my own fault I believe, I was surprised to work through my first year's tax return to realize partner distributions from an LLC would pay self-employment tax.  Is this definately the case, and might I have been wrong to structure the business as an LLC with multiple members?  I've read that chapter S corp sharholders don't pay self-employment tax, but I'm sure it's not that clear cut.  My annual income is $150K+.

A:

As I've discussed several times in my blog, such as this one, there are differences of opinion over whether the K-1 net profit distribution from an LLC is subject to SE tax. 

Guaranteed payments or payments made to LLC members that are specifically identified as being for services rendered are subject to SE tax.  That's not really debatable. 

My opinion on the K-1 net profit hasn't changed on this matter because no laws or regulations have been passed firming up the issue; so it is essentially voluntary. 

You may also want to download and listen to Ed Zollars' podcast  from July on SE tax and LLCs.  I just found it a short while  back.  He has a lot of code cites, and emphasizes that the IRS is afraid to firm up the rules after issuing some temporary and proposed regs.  You can download it from his website here.

There are plenty of other tax pros around the country who have the same opinion as mine on this matter.  If your LLC's tax pro isn't one of them, you will have to decide if that's a big enough issue to warrant finding a new one.

Good luck.

Kerry Kerstetter

Follow-up:

Thanks for the information.  I'm reading that some people believe an s-corp has a more favorable tax position than a multi-member LLC where each member does not pay self-employment tax (as your blog recommends).  Are there any advantages from moving to an s-corp, assuming net income is always drawn from the business?

My Reply:

While the SE tax issue is still in the gray area for LLCs, things are a bit more settled with S corps.  Trying to avoid all payroll taxes via an S corp is dangerous because IRS has the power to reclassify S corp income as W-2 compensation (with all of the related payroll taxes) if they are not satisfied that the corp has already set up enough.

This issue has been around for decades; so any experienced tax pro should be able to help you see how it would affect your particular business.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 1/11/2006 01:34:00 PM Send this post: