[Federal Register Volume 59, Number 249 (Thursday, December 29, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-31434]
[[Page Unknown]]
[Federal Register: December 29, 1994]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[EE-45-94]
RIN 1545-AS94
Self-Employment Tax Treatment of Members of Certain Limited
Liability Companies
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed amendments to the regulations
on the tax on self-employment income under section 1402 of the Internal
Revenue Code of 1986. The proposed regulation concerns the treatment of
members of certain limited liability companies. Under the proposed
regulation, certain members of limited liability companies are treated
as limited partners for self-employment tax purposes.
DATES: Written comments and requests to appear at a public hearing must
be received by March 29, 1995.
ADDRESSES: Send submissions to: CC:DOM:CORP:T:R [EE-45-94], room 5228,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions may be hand delivered between
the hours of 8:00 a.m. and 5:00 p.m. to: CC:DOM:CORP:T:R [EE-45-94]),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the definition of manager,
D. Lindsay Russell, (202) 622-3050; concerning other aspects of the
regulation, Marie Cashman, (202) 622-6040; concerning submissions and
the hearing, Carol Savage, (202) 622-8452.
SUPPLEMENTARY INFORMATION:
Background
This document proposes amendments to the Income Tax Regulations (26
CFR part 1) under section 1402 of the Internal Revenue Code (Code).
Self-Employment Contributions Act (SECA) taxes are imposed by
section 1401 of the Code on the self-employment income of every
individual. Self-employment income is defined by section 1402(b) as the
net earnings from self-employment derived by an individual, subject to
certain exceptions. Section 1402(a) defines net earnings from self-
employment generally as the gross income derived by an individual from
any trade or business carried on by such individual, less the allowable
deductions, plus the individual's distributive share, whether or not
distributed, of income or loss described in section 702(a)(8) from any
trade or business carried on by a partnership of which the individual
is a member, unless a specific exception applies.
One provision under section 1402 that would except a partner's
distributive share under section 702(a)(8) from net earnings from self-
employment is section 1402(a)(13). That section excepts from net
earnings from self-employment the distributive share of any item of
income or loss of a limited partner, as such, other than guaranteed
payments described in section 707(c) made to that partner for services
actually rendered to or on behalf of the partnership, provided the
payments are established to be in the nature of remuneration for
services.
In recent years, virtually all of the states and several foreign
jurisdictions have enacted laws providing for the formation of limited
liability companies (LLCs). Although local law varies as to the
requirements for establishing an LLC, the common denominator is that
none of the members of an LLC are liable for the debts and obligations
of the LLC beyond their contributions to the LLC (absent an express
assumption of liability by a member if authorized under the applicable
LLC statute). In addition, under local law LLCs are generally managed
by elected or designated ``managers,'' who may be members of the LLC.
However, in some jurisdictions, LLCs need not be managed by elected or
designated managers. In those cases, all members of the LLC have
management authority.
LLCs in most jurisdictions may be classified for Federal tax
purposes either as partnerships or as associations that are taxable as
corporations, depending on the characteristics of the LLC. For those
LLCs that are properly classified as partnerships for Federal tax
purposes, an important issue is the treatment of its members for
purposes of the self-employment tax under section 1401 of the Code.
Specifically, the issue is whether any of the members are properly
treated as ``limited partners'' within the meaning of section
1402(a)(13) of the Code.
Explanation of Provisions
The regulation contained in this notice proposes to amend the
regulations under Sec. 1.1402 to add a new section (a)-18 that
addresses the self-employment tax treatment of members of an LLC that
is classified as a partnership for Federal tax purposes. For purposes
of this provision, an LLC includes entities formed under the law of a
foreign jurisdiction.
The proposed regulation provides that, generally, a member's net
earnings from self-employment include the member's distributive share
(whether or not distributed) of income or loss from any trade or
business carried on by an LLC. However, the regulation provides that a
member of an LLC is treated as a limited partner for purposes of the
exception in section 1402(a)(13) if: (1) the member is not a manager,
and (2) 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 in that limited partnership under
applicable law. If a member of an LLC is treated as a limited partner
under this proposed regulation for purposes of section 1402(a)(13),
then the member's distributive share of income or loss from the LLC
will not be included in net earnings from self- employment, except for
guaranteed payments for services.
For purposes of the first requirement described above, a manager is
defined as a person who, alone or together with others, is vested with
the continuing exclusive authority to make the management decisions
necessary to conduct the business for which the LLC was formed. Under
the proposed regulation, if there are no designated or elected managers
of the LLC who have continuing exclusive authority to manage the LLC,
then all of the members will be treated as managers, even if some
members have greater management authority than others under the
applicable LLC statute and the LLC's controlling documents.
The second requirement described above is intended to address two
concerns. First, some states prohibit the conduct of certain activities
through partnerships generally or limited partnerships in particular.
Thus, one purpose of this second requirement is to make clear that a
business operating through an LLC does not obtain a result for self-
employment tax purposes that it would not be able to achieve by
operating as a limited partnership.
Second, under applicable law, a limited partner may become liable
for the obligations of a limited partnership as a general partner when
the limited partner participates in the management or control of the
business. Thus, another purpose of the second requirement is to ensure
that both a member of an LLC and a limited partner in a limited
partnership who participate in the management or control of the entity
to the same extent are treated in the same manner for self-employment
tax purposes.
For foreign jurisdictions that do not have limited partnership
statutes but have LLC statutes, the effect of the proposed regulation
would be to not permit any of the members of an LLC formed in those
jurisdictions to be treated as limited partners for purposes of section
1402(a)(13). Comments are requested concerning the appropriateness of
this result and suggestions for alternative approaches.
Proposed Effective Date
This regulation is proposed to be effective for the member's first
taxable year beginning on or after the date on which this regulation is
published as a final regulation in the Federal Register.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do
not apply to these regulations, and, therefore, a Regulatory
Flexibility Analysis is not required. Pursuant to section 7805(f) of
the Internal Revenue Code, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Comments and Public Hearing
Before this proposed regulation is adopted as a final regulation,
consideration will be given to any written comments (a signed original
and eight (8) copies) that are submitted timely to the IRS. All
comments will be available for public inspection and copying.
A public hearing has been scheduled for June 15, 1995, beginning at
10:00 a.m., in the Internal Revenue Service Auditorium, Seventh Floor
7400 Corridor, Internal Revenue Building, 1111 Constitution Avenue,
N.W., Washington, D.C.. Because of access restrictions, visitors will
not be admitted beyond the Internal Revenue Building lobby more than 15
minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons who wish to present oral comments at the hearing must
submit written comments by March 29, 1995, and submit an outline of the
topics to be discussed and the time to be devoted to each topic (signed
original and eight (8) copies) by March 29, 1995.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal author of this regulation is Marie Cashman, Office of
the Associate Chief Counsel, Employee Benefits and Exempt
Organizations, IRS. However, other personnel from the IRS and Treasury
department participated in its development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Secs. 1.1402(a)-1 through 1.1402(a)-3 [Amended]
Par. 2. Section 1.1402(a)-1 through (a)-3 is amended by removing
each reference to ``Sec. 1.1402(a)-17'' and by adding ``Sec. 1.1402(a)-
18'' in its place.
Par. 3. A new Sec. 1.1402(a)-18 is added to read as follows:
Sec. 1.1402(a)-18 Members of certain limited liability companies.
(a) In general. Except as otherwise provided in section 1402(a), an
individual's net earnings from self-employment include the individual's
distributive share (whether or not distributed) of income or loss from
any trade or business carried on by a limited liability company (LLC)
of which the individual is a member.
(b) Certain members treated as limited partners. Solely for
purposes of section 1402(a)(13), a member of an LLC will be treated as
a limited partner only if--
(1) The member is not a manager of the LLC, and
(2) 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 in that limited partnership under
applicable law.
(c) Definitions--(1) Limited liability company. Solely for purposes
of this section, LLC means an organization that--
(i) Is formed under a law that allows the limitation of the
liability of all members for the organization's debts and other
obligations within the meaning of Sec. 301.7701-2(d), and
(ii) Is classified as a partnership for Federal tax purposes.
(2) Member. Solely for purposes of this section, member means any
person who owns an interest in the LLC.
(3) Manager. Solely for purposes of this section, manager means a
person who, alone or together with others, is vested with the
continuing exclusive authority to make the management decisions
necessary to conduct the business for which the LLC was formed.
Generally, an LLC statute may permit the LLC to choose management by
one or more managers (whether or not members) or by all of the members.
If there are no elected or designated managers (as so defined) of the
LLC, each member will be treated as a manager for purposes of this
section.
(d) Effective date. This section is effective beginning with the
member's first taxable year beginning on or after [INSERT DATE THIS
SECTION IS PUBLISHED AS A FINAL REGULATION IN THE FEDERAL REGISTER].
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 94-31434 Filed 12-28-94; 8:45 am]
BILLING CODE 4830-01-U
