Wednesday, January 20, 2010

LLC Member’s Income Subject to Self-Employment Tax

Tax law had been unclear for years to what extent self-employment tax must apply to income earned by a Limited Liability Company member. Taxpayers and the IRS over the years have taken positions that LLC units are the same as limited partnership interests, general partner interests, or sometimes one and sometimes the other. Congress has not passed any law to clarify the issue. Recently, however, an important Tax Court case, Garnett (132 T.C. No. 19), provided some clarification. Although the case was about the application of the passive activity rules to LLC income, the court’s conclusion on the nature of LLC units impacts self-employment tax. The tax court found that LLC units are not the same as limited partnership interests under federal tax law. In the past some had argued that LLC income is not subject to self-employment tax because LLC interests are the same as limited partnership interests, which are by definition not subject to self-employment tax. In light of this new court case, that argument is no longer valid.