On Sept. 5, 2014, the IRS released Chief Counsel Advice (CCA) 201436049, which addresses the employment tax consequences for limited liability company (LLC) members who also provide services on behalf of the LLC. The dispute has its roots in the self-employment tax treatment of limited partners. Limited partners are not subject to self-employment taxes, and the CCA addresses whether members of an LLC are the equivalent of limited partners for self-employment tax purposes.
The LLC in the CCA is a management company that indirectly owns and manages several investment funds and has full authority and responsibility to manage and control the affairs and business of each fund, including market research and trading activities for the investment funds. In consideration for its work with the investment funds, the management company received a quarterly management fee.
In the years at issue, members of the management company received a guaranteed payment for services provided along with their distributive shares of partnership income. These members paid self-employment tax on the guaranteed payments but argued that none of their distributive share of income should be subject to self-employment tax.
Section 1402(a)(13) of the Internal Revenue Code provides an exemption from self-employment tax for a limited partner’s distributive share of income from a partnership. The fundamental question addressed in the CCA is whether an individual’s distributive share of income from an LLC is treated the same as income received by limited partners. The CCA analyzed a number of state law factors that, in the view of the IRS, would exclude an active participant in a business from limited partner classification. The CCA also analyzed the legislative history of the Section 1402(a)(13) limited partner exclusion and noted that this exclusion from self-employment tax was intended to prevent the imposition of self-employment taxes on income that was investment in nature. For these reasons, the CCA concludes that the distributive share income of the LLC members was subject to self-employment tax.
The self-employment tax treatment of LLC members has long been an area of controversy between taxpayers and the IRS. Controversial proposed regulations were released in 1997 on this topic, but they were never finalized. The U.S. Department of the Treasury’s Office of Tax Policy 2014-2015 Priority Guidance Plan includes a project addressing the treatment of LLCs for purposes of the Section 1402(a)(13) exclusion from self-employment tax.
The CCA is written advice provided by the IRS Office of Chief Counsel to an IRS audit team solely in connection with the item under examination. Although not binding on other taxpayers, the CCA does offer a window into the IRS’ current thoughts on the self-employment tax treatment of LLC income. Individuals who are members of LLCs should continue to monitor developments in this area.