SE tax treatment of LLCs' members.

Prop. Regs. Sec. 1.1402(a)-18 governs the self-employment (SE) tax treatment of members of limited liability companies (LLCs) classified as partnerships for Federal tax purposes. Members that may be treated as limited partners under local law generally may exclude their distributive shares from net income from SE. Prop. Regs. Sec. 1.1402(a)-18 will be effective for the member's first tax year beginning on or after the date on which it is published in final form in the Federal Register.

In general, SE taxes are imposed on income an individual derives from any trade or business that individual carries on (less allowable deductions), plus the individual's distributive share of income or loss from a trade or business carried on by a partnership of which the individual is a member. Sec. 1402(a)(13) excepts from "net earnings from self-employment" a limited partner's distributive share of income or loss (other than guaranteed payments made to the limited partner for services rendered to the partnership or on behalf of it).

LLC statutes have been enacted by virtually all the states and several foreign jurisdictions. Under local laws they are generally managed by elected or designated managers. However, in some jurisdictions, an LLC need not be administered by a manager, in which case all members of the LLC have management authority. For Federal tax purposes, most LLCS are classified as partnerships.

For SE tax purposes, in determining the treatment of an LLC member, the proposed regulations draw an analogy to the partnership rules. Prop. Regs. Sec. 1.1402(a)-18(a) provides that a member's net earnings from SE will generally include the member's distributive share of income or loss from any trade or business carried on by the LLC.

However, Prop. Regs. Sec. 1.1402(a)-18(b) provides that an LLC member will be treated as a limited partner if - the member is not a manager (defined in Prop. Regs. Sec. 1.1402(a)-18(c)(3) as a person vested with the continuing authority to make the management decisions necessary to conduct the LLC's business), and - the entity could have been formed as a limited partnership rather than an LLC in the same jurisdiction and the member could have qualified as a limited partner under applicable local law.

If an LLC member is treated as a limited partner for Sec. 1402(a)(13) purposes, the member's distributive share of income or loss from the LLC, except for guaranteed payments for services, will not be included in net earnings from SE.