Self-Employment Tax Reduction for LLC´s Taxed as Partnerships

This option is available to Multi-Member LLC clients if their tax professionals recommend it.

Per IRS Prop. Reg. 1402 (a)-2 [particularly 1402(a)(13)], LLCs taxed as partnerships may provide self-employment tax reduction (similar to the self-employment tax S-Corp benefits but without the S-Corp prohibitions). The Multi-Member LLC must have two classes of LLC interests (“active” and “passive”), all but one LLC owner/member may own both “active” LLC interests and “passive” LLC interests as long as there is one LLC owner/member who owns only a “passive” interest, does not work the LLC business more than 500 hours a year, does not have contracting authority for the LLC, and owns at least 20% of the LLC.

The LLC owner/members with “active” LLC interests are designated as managers and for their management duties they receive guaranteed payments (equaling “reasonable compensation” in S-Corp terminology) upon which they pay self-employment tax but then for their “passive” LLC interests they receive dividends upon which they do not pay self-employment tax. The one completely “passive” LLC owner/member receives only dividends upon which he/she does not pay self-employment tax.

When I organized “Form” LLCs, I did not offer this provision.

“The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.” Justice George Sutherland, Gregory v. Helvering, 293 U.S. 465, 469 (1934).