K1 income not being categorized as earned income

[Pita316]

Hi,

I’m trying some “what if” scenarios using TT2020 Premier.   I’m a partner in an LLC.  The LLC is in California and I am a resident of California. I am actively involved in the operation of the business.  The LLC and dividend/interest are my only source of income.

For 2020, I received a K1 and claimed the 25k income (form 1065 submitted).  I’m trying to see what would happen if I had contributed to my Roth IRA.  (I’m 65+, so trying to contribute 7k).   I must be checking the wrong boxes because TT keeps telling me that I have excess contributions because my income is zero.  From what I’ve read, I need to have earned income to contribute to a Roth IRA.  I would appreciate it if someone could tell me what I should be doing in TT so it would see my 25K as earned income.

I’ve read through the TT discussions and found one that may apply (Mike300, posted 6/30/20).  But just want to be sure.

Thank you

[GeorgeDenseff]

K1 is not normally considered earned income.  You are not paying Social  Security taxes on it and it is not eligible for retirement savings.

[Mike9241]

if the income is earned income there will be an amount in box 14A of the k-1. 

Arguably, LLC members who are active in management or perform substantial services related to the LLC’s business are subject to SE tax, while those who more closely resemble passive investors should be treated like limited partners. Unfortunately, guidance on this subject has been scarce. The IRS issued proposed regulations in 1997, but to this day hasn’t finalized them (although it follows them as a matter of internal policy).

Under the proposed regulations, an LLC member’s distributive share is exempt from SE tax unless the member:

• Is personally liable for the LLC’s debts,
• Has authority to contract for the LLC, or
• Participates in the LLC’s business for more than 500 hours per year.

There’s a special rule, however, for “service partners” in service partnerships, such as law and accounting firms, medical practices, and architecture and engineering firms. Generally, they may not claim limited partner status regardless of their level of participation.

Some LLC members have argued that the IRS’s failure to finalize the regulations supports the claim that their distributive shares aren’t subject to SE tax. But the IRS routinely rejects this argument and, in recent years, has successfully litigated its position. The courts have imposed SE tax on LLC members unless, like traditional limited partners, they lack management authority and don’t provide significant services to the business. And some courts have ruled that mere management control, by itself, is enough to defeat limited partner status, regardless of whether that control is exercised.

based on your statement if box 14A is blank, the return preparers are taking what the IRS would reject, that you are not subject to SE tax. 

Sine a Roth contribution is not deductible for Federal purposes the only possible Federal tax benefit would be the Savers Credit 

https://turbotax.intuit.com/tax-tips/tax-deductions-and-credits/what-is-the-savers-credit/L3LyopRkK 

[VolvoGirl]

The LLC might also have to give you a W2 for wages to count as earned income, especially if you are working in it.

[Anonymous_]

I agree with @Mike9241, generally, and specifically with respect to earned income being reported in Box 14 (with an A code) on the K-1.

Another possibility would be in the nature of a guaranteed payment for services (Box 4A) but a W-2 would not be issued to a member of an LLC unless an election was made for the LLC to be treated as a corporation (which does not appear to be the case).

[Mike9241]

for an LLC all guaranteed payments are subject to SE tax and should be included on line 14A of the K-1.

https://www.irs.gov/faqs/small-business-self-employed-other-business/entities/entities-1 

  If you're a general partner of a partnership (or the equivalent in an LLC) that carries on a trade or business, your net earnings from self-employment include your distributive share of the income or loss from that trade or business. General partners must also include guaranteed payments as net earnings from self-employment.

I would rephrase the last sentence above.

General partners (or the equivalent in an LLC) must also include guaranteed payments as net earnings from self-employment.

[Anonymous_]

Correct.

See https://www.irs.gov/faqs/small-business-self-employed-other-business/entities/entities-1

[Pita316]

Thanks to all for your comments.

FYI: One of the business partners has a CPA. That CPA prepared the returns for the business and all the K1's. 

I checked my K1 and see in Part I-G, 'Limited partner or other LLC member' is checked.

Part III-1, 'ordinary business income' shows my income. Part III-14, 'self-employment earnings' is blank.

I guess I need to talk to the partner with the CPA and find out what he told the CPA.  I'm assuming, based on that information, the CPA categorized each partners income as 'ordinary business income' instead of 'self-employment income'. 

For 2021 taxes, I'll have that partner contact his CPA to see if we're able to classify income as 'self-employment income' instead of 'ordinary business income'.

[Anonymous_]

The default, for partners who materially participate providing services to the partnership, would be for ordinary income in Box 1 to also be included in Box 14A.

[Mike9241]

Part III-14, 'self-employment earnings' is blank.

that's the problem. as blank Turbotax is treating the income as passive not earned. 

if you were a limited partner in an LLP that would be correct since LP's are not supposed to have an active role in the LP. now an LLC member may or may not actively participate in the activity and the IRS never issued final regs.

LIMITED LIABILITY COMPANY UNCERTAINTY
Over the years, many LLC members have taken the position that they’re equivalent to limited partners and, therefore, exempt from SE tax (except on guaranteed payments for services). But there’s a big difference between limited partners and LLC members. Both enjoy limited personal liability, but, unlike limited partners, LLC members can actively participate in management without jeopardizing their liability protection.

Arguably, LLC members who are active in management or perform substantial services related to the LLC’s business are subject to SE tax, while those who more closely resemble passive investors should be treated like limited partners. The IRS issued proposed regulations to that effect in 1997, but hasn’t finalized them — although it follows them as a matter of internal policy.

Some LLC members have argued that the IRS’s failure to finalize the regulations supports the claim that their distributive shares aren’t subject to SE tax. But the IRS routinely rejects this argument and has successfully litigated its position. The courts generally have imposed SE tax on LLC members unless, like traditional limited partners, they lack management authority and don’t provide significant services to the business.

if you or others provide significant services or actively participate in management, the return should be amended to reflect their SE income.   Failure may invite an IRS audit and then there would follow a bill for SE taxes. penalties and interest.  this might not occur for several years meanwhile penalties and interest are increasing. do not wait until next year. get the facts and if necessary amend prior returns.

on the k-1 to be earned income both box 1 and box 14 must have numbers. box 1 is for income tax purposes and has no effect on the S-E tax while box 14 is used to compute S-E tax and has no effect on taxable income

[Pita316]

Sorry again for the late reply and thank you again for your explanation.  Much appreciated. I will forward it the the partner with the CPA.