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Can you explain how this discrepancy is possible? see below but the IRS is challenging
Fron a 2018, article. In 1997, in an effort to resolve the issue, the Treasury Department issued Prop. Regs. Sec. 1.1402(a)-2, which provided that an LLC member's distributive share would not be subject to self-employment tax unless the member had:
Personal liability for the LLC's debts;
Authority to contract for the LLC; or
Participated in the LLC's business for more than 500 hours per year.
In addition, "service partners" in a service partnership were automatically excluded from claiming limited partner status; all their distributive share of income would be subject to self-employment taxes.
Immediately after the proposed regulations were issued, politicians and pundits alike claimed that the regulations were an attempt by Treasury to legislate without Congress's approval. Congress subsequently passed a one-year moratorium prohibiting Treasury from finalizing the regulations (Section 935 of the Taxpayer Relief Act of 1997, P.L. 105-34). Treasury has yet to finalize the regulations some 20 years later. This failure to issue final self-employment tax regulations has provided some taxpayers with support for a reporting position to claim that distributive income allocated to an LLC member, even a service partner, is excludable for self-employment tax purposes. The IRS has historically disagreed with this position and has recently begun to litigate perceived abusive fact patterns in the courts to counteract this otherwise unchecked reporting position.
RECENT CASE LAW FILLS THE VOID
In a series of recent court cases, the IRS has, for the most part, successfully challenged LLC members who have attempted to exploit the ambiguity created from the IRS's failed effort to issue final self-employment tax regulations. In attempting to discern who should be treated as "limited partners" for self-employment tax purposes, the courts have examined the legislative intent underlying the Sec. 1402(a)(13) exception and found that members or owners who provide services to a business, who have management authority, or who possess other characteristics inconsistent with those of traditional limited partners should be subject to self-employment tax. In this regard, these decisions seem to have come full circle in that they are judicially reviving two of the three original factors included in the 1997 proposed regulations used to determine the status of LLC members for self-employment tax purposes: management control and participation.
The first case involved a group of tax attorneys who had organized their firm as an LLP (Renkemeyer, Campbell, and Weaver, LLP, 136 T.C. 137 (2011)). The attorneys' interests in the LLP had been split into "general managing partner partnership units" and "investing partnership units," and the partners had treated income allocable to the investing partnership units as limited partnership investment income not subject to self-employment tax. The Tax Court rejected this approach on two grounds. First, the court noted in passing that all the partners had management authority under state law governing LLPs. Second, and more importantly, the court emphasized that none of the partnership's income should be excluded from self-employment tax because all of the partners were active participants in the partnership's business. In its decision, the Tax Court stated: "The legislative history of section 1402(a)(13) does not support a holding that Congress contemplated excluding partners who performed services for a partnership in their capacity as partners (i.e., acting in the manner of self-employed persons), from liability for self-employment taxes." After Renkemeyer, taxpayers were put on notice that LLC members providing services to an LLC would be at risk of having their distributive shares treated as self-employment income.
Following on the heels of Renkemeyer, a 2012 district court case examined the extent to which a husband and wife who were the sole members of an LLC and received W-2 wage income from the LLC should be able to exclude their distributive shares of the LLC's income from their self-employment income (Riether, 919 F. Supp. 2d 1140 (D.N.M. 2012)). The couple had argued that their distributive shares were akin to investment income since they had paid themselves a salary as compensation for the services they provided to the LLC. Citing Rev. Rul. 69-184, the court first noted that "a partner who participates in the partnership business is a 'self-employed individual'" and cannot simultaneously be treated as an employee.
The most relevant and novel part of the court's ruling, however, suggested that management control alone would be sufficient to taint an LLC member's income. Explaining its position, the court stated that the taxpayers did not "resemble limited partners, which are those who lack management powers ... whether the Plaintiffs were active or passive in the production of the LLC's earnings, those earnings were self-employment income" (emphasis added).
2. Does this imply that the business covered my portion of the taxes?2a. Can't be done, self-employment tax is done at the 1040 level. self-employment tax can only be computed and paid at the 1040 level. A LLC cannot pay it for you and thus exempt the income from being subject to SE Taax on your return.
