Self-employment tax for limited partners.

The distributive share of a limited partner is not subject to self-employment (SE) taxes. The IRS recently released proposed regulations under Sec. 1402, providing a definition of limited partner for purposes of paying SE taxes. Prop. Regs. Sec. 1.1402(a)-18 was previously issued in December 1994 and treated certain members of limited liability companies (LLCs) as limited partners for SE tax purposes. Prop. Regs. Sec. 1.1402(a)-18 has been withdrawn in response to public comment. Public hearings on the new proposed regulations are scheduled for May 21, 1997.

The IRS has taken a new approach to solving its dilemma on how to treat LLC members under the SE tax rules. The newly proposed rules seem to be more consistent in their application from one fact pattern to another. Furthermore, the newly proposed rules provide us with "bright lines" that possibly can be used to minimize SE taxes.

The new proposed regulations define limited partners under Sec. 1402 and apply to all entities classified as partnerships for Federal tax purposes, regardless of state law classification. The regulations are based on the relationship between the partner, the partnership and die partnership's business.

An individual will be a limited partner, unless die individual -- has personal liability for partnership debts due to partner status; -- has authority to contract on behalf of the partnership under the laws where die partnership is organized; or -- participates in the partnership's business for more than 500 hours per year.

An individual who provides services in a partnership providing professional services in health, law, engineering, architecture, accounting, actuarial science or consulting cannot be a limited partner.

An individual who is not a limited partner, but holds more than one class of interests in a partnership, may be able to exclude a portion of net earnings from liability for SE tax.

In addition, individuals who fail the participation test for limited partner status may still qualify in some instances as limited partners and exclude their distributive share of partnership income from SE tax.

The reproposed regulations deal with SE tax on distributive shares only. Guaranteed payments under Sec. 707(c) are still included in an individual's calculation of SE tax, regardless of classification under these proposed regulations.