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Federal Income Taxation of LLC Members

Share: Author(s) Charles R. Beaudrot, Jr. (http://www.mmmlaw.com/our-people/employee-directory/attorneys/charlesr.-beaudrot-jr)
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Practice Areas Tax (http://www.mmmlaw.com/practice-areas/tax) Overview If an LLC is treated as a partnership for federal income tax purposes, the entity itself will not be subject to federal income tax. Instead, each member will be taxed on the member's allocable share of the LLC's taxable income. Generally, the character of an item of income or loss will be the same for a member as it is for the LLC. Each member of an LLC must take into account the member's distributive share of an LLC's income and loss as determined by the LLC's operating agreement, unless the operating agreement does not provide for such allocations or such allocations under the operating agreement do not have "substantial economic effect," in which case such member's distributive share will be determined in accordance with the member's interest in the LLC. In addition, income, gain, loss, and deductions with respect to contributed property must be allocated among the members to take account of any difference between the tax basis of the property and its fair market value at the time of contribution. A member will be entitled to deduct its share of an LLC's tax losses to the extent of the tax basis in its LLC interest. Any loss in excess of such tax basis may be carried over indefinitely and deducted, subject to various limitations (e.g., passive activity and at-risk rules), in any subsequent year in which the tax basis in such member's LLC interest is increased above zero. Generally, no gain or loss is recognized to either the contributing member or the LLC on a member's contribution of property to the LLC. Similarly, no gain or loss is generally recognized by the LLC or the distributee member on the distribution of property to such member, except to the extent that any money distributed exceeds the tax basis of such member's LLC interest immediately before the distribution. On a sale of an LLC interest, the selling member will recognize gain or loss based on the difference between the amount realized and the member's tax basis in its interest. Tax Basis in LLC Interest

In general, the initial tax basis of a member who acquires an LLC interest from the LLC will be equal to the amount of money and the tax basis of any property that the member contributes to the LLC in exchange for such interest. The tax basis thus determined will be increased by such member's share of the LLC's liabilities, by its share of the LLC's income, and by any subsequent capital contributions. The member's tax basis will be reduced (but not below zero) by the member's share of LLC distributions and losses and also by any decrease in such member's share of the LLC's liabilities. IRC 752 embodies the statutory rules for sharing LLC liabilities. That Section provides that any increase in a partner's share of a partnership's liabilities, or any increase in a partner's individual liabilities by reason of assuming a partnership's liabilities, will be considered a contribution of money by such partner to the partnership. Conversely, any decrease in a partner's share of a partnership's liabilities, or any decrease in a partner's individual liabilities by reason of a partnership assuming such liabilities, will be considered a distribution of money to the partner by the partnership. Unfortunately, the statute does not provide for the manner in which a partner's share of liabilities will be determined. Instead, one must look to the Regulations. The 752 Regulations treat all liabilities as either recourse or nonrecourse. A partnership liability is a recourse liability to the extent that any partner (or a person related to that partner) bears the economic risk of loss for that liability. A partner's share of a recourse partnership liability equals the portion of that liability, if any, for which that partner or a related person bears the economic risk of loss with respect to such liability. Basically, a partner is treated as bearing the economic risk of loss for a partnership liability to the extent that the partner or related person would be obligated to make a contribution or payment with respect to a partnership liability (and would not be entitled to be reimbursed for the contribution or payment by another partner, a person related to another partner, or the partnership), if the partnership constructively liquidated. The following events are deemed to occur in a constructive liquidation: (1) all of the partnership's liabilities become due and payable in full; (2) with the exception of property contributed to secure a partnership liability, all of the partnership's assets (including money) become worthless and have a value of zero; (3) the partnership disposes of all of its assets in a fully taxable transaction for no consideration (other than relief from liabilities for which the creditor's right to repayment is limited solely to one or more assets of the partnership); (4) all items of income, gain, loss, and deduction for the year are allocated among the partners; and (5) the partnership completely liquidates. A partnership liability is a nonrecourse liability to the extent that no partner or related person bears the economic risk of loss for that liability. A partner's share of the nonrecourse liabilities of a partnership equals the sum of the amounts determined under the following three tiers: first, the partner's share of "partnership minimum gain" determined pursuant to Code 704 (b) and the Regulations thereunder; second, the amount of any taxable gain that would be allocated to such partner under Code 704 (c) principles if the partnership disposed of all partnership property subject to one or more partnership nonrecourse liabilities in full satisfaction of such liabilities and for no other consideration; and third, such partner's share of any partnership nonrecourse liabilities in excess of those allocated pursuant to the first two tiers, as determined in accordance with such partner's share of partnership profits taking into account all facts and circumstances relating to the economic arrangement of the partners. Capital Accounts and Their Role in LLC Taxation The partnership agreement may specify the partners' interests in profits for purposes of allocating excess nonrecourse liabilities, provided the interests so specified are reasonably consistent with valid allocations under the 704 (b) Regulations of some other significant item of partnership income or gain. The Regulations also provide an alternative under which excess nonrecourse liabilities may be allocated among the partners in accordance with the manner in which it is reasonably expected that the deductions attributable to those nonrecourse liabilities will be allocated. Excess

nonrecourse liabilities are not required to be allocated under the same method each year. It is important to recognize that a member's interest in an LLC is separate and distinct from the member's capital account. A capital account is basically a measure of a member's equity in an LLC. Computation of the capital account begins with the amount of money and the fair market value (not the tax basis) of other property contributed by such member to the LLC (net of liabilities secured by such contributed property that the LLC is considered to assume or take subject to under IRC 752 (http://www.law.cornell.edu/jureeka/index.php?doc=U.S.C.&title=26&sec=752& sec2=undefined&year=undefined)), and is increased by the member's share of the LLC's income and gain. The member's capital account is decreased by the amount of money and the fair market value of property (again, not the tax basis) distributed to such member (net of liabilities secured by such distributed property that such member is considered to assume or take subject to under Code 752), and such member's share of the LLC's losses, deductions, and nondeductible expenditures. A member's capital account does not reflect such member's share of the LLC's liabilities except to the extent that such liabilities are actually assumed by the member and the creditor is aware of such assumption and can directly enforce the member's obligation. Thus, while there will be an increase in the member's tax basis in its LLC interest for the increase in the member's share of the LLC's liabilities, generally there will be no corresponding increase in the member's capital account. The Regulations also permit an adjustment to the members' capital accounts to reflect the revaluation of LLC property on the LLC's books, provided that the adjustments are made principally for a substantial nontax business purpose either (1) in connection with a contribution or distribution of money or other property (other than a de minimis amount) as consideration for the acquisition or relinquishment of an interest in the LLC; (2) under generally accepted industry accounting practices, provided that substantially all of the LLC's property (excluding money) consists of stock, securities, commodities, options, warrants, futures, or similar instruments that are readily tradable on an established securities market; or (3) in connection with a liquidation of the LLC. Such adjustments must be based on the fair market value of LLC property on the date of adjustment and must reflect the manner in which the unrealized income, gain, loss, or deduction inherent in such property (that has not been previously reflected in the capital accounts) would be allocated among the members if there were a taxable disposition of such property for such fair market value on that date. The members' capital accounts must be subsequently adjusted for book depreciation, depletion, amortization, and gain or loss with respect to the booked-up value of the property. The members' distributive shares of tax depreciation, depletion, amortization, and gain or loss with respect to the property must also be determined to take into account the resulting book/tax disparity according to the rules of Code 704(c). Generally, under IRC 704(c) (http://www.law.cornell.edu/jureeka/index.php?doc=U.S.C.&title=26&sec=704&sec2=(c)&year=undefined), certain tax allocations must be made to the contributing member with respect to the difference between the book value (fair market value) of contributed property and its tax basis, so that the difference between tax basis and book value at the time of contribution is ultimately recognized by the contributing member. Allocation of Profits and Losses Each member of an LLC must take into account the member's distributive share of all items of the LLC's income, gain, loss, deduction, and credit for federal income tax purposes. In general, an LLC's operating agreement determines a member's distributive share of these items, unless the agreement does not provide for such allocations or such allocations under the agreement do not have "substantial economic effect," in which case such member's distributive share of these items will be determined in accordance with its interest in the LLC, taking into account all facts and circumstances. If the operating agreement provides for the allocation of such items to a member, the Regulations state that there are three ways in which such allocation will be respected under IRC 704 (b) (http://www.law.cornell.edu /jureeka/index.php?doc=U.S.C.&title=26&sec=704&sec2=(b)&year=undefined)and the Regulations thereunder: the

allocation can have substantial economic effect; the allocation can be in accordance with the member's interest in the LLC, taking into account all facts and circumstances; or, the allocation can be deemed to be in accordance with the member's interest in the LLC. Substantial Economic Effect The determination of whether an allocation to a member has substantial economic effect is a two-part analysis: first, the allocation must have economic effect, and second, the economic effect must be substantial. In order for an allocation to have economic effect, it must be consistent with the underlying economic arrangement of the members -- if there is an economic benefit or burden that corresponds to an allocation, the member to whom the allocation is made must receive such economic benefit or bear such economic burden. Generally under the Regulations, an allocation will have economic effect if, and only if, throughout the full term of the LLC, the operating agreement provides that (1) the members' capital accounts will be maintained in accordance with the Regulations; (2) positive capital account balances will determine the distribution of an LLC's assets in liquidation of the LLC (or any member's interest in the LLC); and (3) each member will be required to restore any deficit in his or her capital account that remains after the distribution of liquidation proceeds, and such amount will be paid to creditors of the LLC or distributed to other members in accordance with their positive capital account balances. If the first two requirements are met but the member to whom an allocation is made is not required to restore a deficit balance in its capital account, such allocation will be considered to have economic effect to the extent such allocation does not cause or increase a deficit balance in such member's capital account (in excess of any limited amount of such deficit that such member is obligated or deemed to be obligated to restore), provided there is a "qualified income offset" provision in the operating agreement. Such an allocation will be considered to have economic effect under what the Regulations refer to as the alternate test for economic effect. A qualified income offset is a provision that requires a member who unexpectedly receives an adjustment, allocation, or distribution described in the Regulations that causes or increases a deficit balance in such member's capital account (in excess of any limited amount of such deficit that such member is obligated or deemed to be obligated to restore), to be allocated income and gain in an amount and manner sufficient to eliminate such deficit balance as quickly as possible. Because most LLCs will not require any of their members to restore negative capital account balances, an operating agreement will need to include a qualified income offset provision. The Regulations provide that, in general, the economic effect of an allocation will be "substantial" if there is a reasonable possibility that the allocation will substantially affect the dollar amounts that the partners will receive, independent of tax consequences. If an allocation has economic effect, but the economic effect is not substantial, such allocation must be based on the members' interests in the LLC. The Regulations contain a safe harbor test in regard to losses and deductions attributable to nonrecourse debt secured by partnership property ("nonrecourse deductions"). Allocations of nonrecourse deductions cannot have substantial economic effect because the creditor alone bears any economic loss attributable to those deductions. Thus, nonrecourse deductions must be allocated in accordance with the members' interests in the LLC. The Regulations provide that allocations of nonrecourse deductions will be deemed to be made in accordance with the members' interests in the LLC so long as the following four requirements are met: (1) Capital accounts are properly maintained in accordance with the 704 (b) Regulations, liquidating distributions are required to be made in accordance with positive capital account balances, and members with deficit capital account balances have a deficit restoration obligation or the operating agreement contains a qualified income offset; (2) the operating agreement provides for allocation of nonrecourse deductions in a manner that is reasonably consistent with allocations that have substantial economic effect of some other significant LLC item attributable to the property securing the nonrecourse debt; (3) the operating agreement contains a "minimum gain chargeback"; and (4) all other material LLC allocations and capital account

adjustments under the operating agreement are recognized under the 704 (b) Regulations. Allocations of nonrecourse deductions not qualifying under this safe harbor must be made in accordance with the members' overall economic interests in the LLC, as determined under the Regulations.

The 704(c) regulations are extraordinarily complex and must be studied carefully in many situations.

At-Risk Rules IRC 465 provides that in the case of individuals and certain closely held C corporations, a loss from certain activities is allowable only to the extent the taxpayer is at-risk for such activity at the close of the taxable year. The at-risk rules apply to all activities engaged in by a taxpayer in carrying on a trade or business or for the production of income. A taxpayer is at-risk with respect to an activity to the extent of (1) the amount of money and the adjusted basis of other property contributed by the taxpayer to the activity, plus (2) amounts borrowed for use in the activity to the extent the taxpayer is personally liable for the repayment of such amounts, or has pledged property, other than property used in such activity, as security for the debt (to the extent of the net fair market value of the taxpayer's interest in such pledged property). In addition, a taxpayer is considered at-risk with respect to the taxpayer's share of any "qualified nonrecourse financing" that is secured by real property used in the activity. Qualified nonrecourse financing is any financing (1) that is borrowed by the taxpayer from a qualified person (i.e., generally an unrelated entity actively engaged in the business of lending money), or that represents a loan from any federal, state, or local government or instrumentality thereof (or is guaranteed by any federal, state, or local government or instrumentality thereof), with respect to the activity of holding real property; (2) with respect to which no person is personally liable for repayment; and (3) which is not convertible debt. A member's share of any qualified nonrecourse financing is determined on the basis of that member's share of LLC liabilities incurred in connection with such financing, within the meaning of Code 752. If an LLC is engaged in an activity that is subject to the at-risk rules, the at-risk limitation is applied at the member level, not at the LLC level. Thus, some members may be subject to the at-risk rules while others are not. Each member is required to determine the amount he or she has at-risk in the LLC at the end of each taxable year. Generally, a member will be at-risk for the amount of money and the tax basis of other property contributed to the LLC by such member, plus amounts borrowed by the LLC for which such member is either personally liable for the repayment thereof or has pledged property (other than its LLC interest or assets owned by the LLC) as security for the loan, to the extent of the fair market value of such pledged property. In addition, if a member is contractually obligated to make additional contributions to the LLC, such member may be entitled to increase its at-risk amount by a portion of the LLC's liabilities, provided they are the types of liabilities that would increase the members at-risk amount if he or she were a general partner in a partnership. A member's share of LLC profits will increase its amount at-risk . If a member's share of the LLC's loss for a taxable year is less than the amount it has at-risk at the end of such year, the deduction for such loss is not limited by Code 465. However, the member must then reduce the amount considered at-risk by the amount of the loss that has been deducted, and the reduced at-risk amount is carried over to the next taxable year. If a member's share of an LLC's loss for a taxable year is greater than the amount at-risk, the deduction in that year is limited to the amount at-risk at the end of the year, and the amount at-risk is reduced to zero. The member's share of the LLC's loss that is not allowable as a deduction by reason of Code 465 in any taxable year may be carried over and deducted in succeeding taxable years to the extent its at-risk basis has increased above zero. When a member's at-risk basis is reduced below zero at the end of any taxable year (for example, by distributions to such member), the member will recognize income to the extent the at-risk basis is reduced below zero. This recapture income, however, is limited to the excess of the losses previously allowed to such member over any amounts previously recaptured, and will be treated as a deduction allocable to the activity for the first succeeding taxable year. It is important to note that the at-risk limitation does not affect the tax basis of a member's interest or the amount of gain or loss realized by a member; it merely limits the amount of loss that may be deducted by a member in a particular year. Passive Activity Rules Individuals, estates, trusts, closely held C corporations, and personal service corporations are subject to the passive activity rules of IRC 469, which generally prohibit those taxpayers from using losses from passive activities to offset nonpassive income. A passive activity loss is the amount by which a taxpayer's passive activity deductions for the taxable year exceed his or her passive activity gross income for the year. A passive activity generally is (1) any activity that involves the conduct of a trade or business and in which the taxpayer does not materially participate, and (2) any rental activity, regardless of the extent to which the taxpayer participates, except for interests in rental real estate owned by certain real estate operators. In addition, an individual who "actively" participates in a rental real estate activity of which he or she owns at least a 10 percent interest may use up to $25,000 of passive losses per year to offset nonpassive income; however, this amount is reduced by 50 percent of the taxpayer's adjusted gross income in excess of $100,000. In applying the passive loss rules, a taxpayer's income and losses are separated into three categories or baskets: (1) passive income; (2) portfolio income (e.g., interest, dividends, and certain royalties); and (3) active income (e.g., salary and wages). Losses from passive activities are allowed to the extent of the taxpayer's passive income, and they cannot be used to offset either portfolio income or active income. Credits arising with respect to passive activities may be used to offset

tax attributable to net passive income. Disallowed passive losses and credits are carried over and used to offset future passive income and tax attributable thereto. Upon the fully taxable disposition of the taxpayer's entire interest in a passive activity, all suspended losses (but not credits) attributable to that activity can be used without regard to the passive loss limitation. "Material participation" in an activity is defined as active involvement in the operations of the activity on a regular, continuous and substantial basis. Generally, an individual is treated as materially participating in an activity for a taxable year if he or she meets one of the following seven tests: 1. The individual participates in the activity for more than 500 hours during such year; 2. The individual's participation in the activity for the taxable year constitutes substantially all of the participation in such activity of all individuals for such year; 3. The individual participates in the activity for more than 100 hours during the taxable year, and that participation is not less than that of any other individual for such year; 4. The activity is a significant participation activity for the taxable year, and the individual's aggregate participation in all significant participation activities during such year exceeds 500 hours; 5. The individual materially participated in the activity for any five taxable years during the ten immediately preceding taxable years; 6. The activity is a personal service activity, and the individual materially participated for any three preceding taxable years; or 7. Based on all the facts and circumstances, the individual participates on a regular, continuous and substantial basis during such taxable year.

A limited partner will not be treated as materially participating in the activities of a limited partnership unless specifically permitted by the Regulations. The IRS has issued temporary Regulations which provide that a limited partner will be deemed to materially participate by qualifying under tests (1), (5), or (6) above. Thus, a limited partner either must participate for more than 500 hours or must have materially participated during five of the last ten years or, if the activity is a personal service activity, any three preceding years. By contrast, an S corporation shareholder will be deemed to materially participate by satisfying any of the seven tests. The determination of whether an activity will be a passive activity is a complex and relatively uncharted area. For a discussion of these complexities see Bryant, Jones & Beaudrot, Georgia LLC/LLP Handbook pps. 128 to 132. Accounting Methods Under Code 446 (c), a taxpayer generally may use either the cash method or the accrual method of accounting. Code 448 (a), however, precludes a "tax shelter" from using the cash method of accounting. A tax shelter is any of the following entities: (1) any enterprise" (other than a C corporation), if at any time interests in such enterprise have been offered for sale in any offering required to be registered with any federal or state agency having the authority to regulate the offering of securities for sale; (2) any "tax shelter" as defined in Code 6662 (d)(2)(C)(ii); and (3) any "syndicate" within the meaning of Code 1256 (e)(3)(B). Although not apparent on first blush, this statute can be read as applying to many LLC's. The IRS has issued several private letter rulings dealing with this issue. In Priv. Ltr. Rul. 9321047 (Feb. 25, 1993), a cash-method law firm operating as a general partnership decided to convert into an LLC. First, the IRS found that the LLC was not an "enterprise" so long as it did not offer interests in itself for sale in an offering required to be registered, which the law firm represented it had never done and would never do. The IRS also found that the LLC was not a "syndicate," noting that this issue depends on how the LLC's members are classified and how its losses are allocated. The IRS found that the members of the LLC were not limited entrepreneurs, based on the law firm's representations that all of the members of the LLC would continue to engage in the practice of law and that all of the members would be required to vote in order for the LLC to take certain actions. Subsequent private letter rulings have included similar representations. Although not discussed, the IRS apparently did not view members of the LLC as being limited partners simply because they would have limited liability. Finally, the IRS found that the LLC was not a "tax shelter" within the meaning of Code 6662 (d)(2)(C)(ii), based on the law firm's representations that the partners would participate in the management of the LLC, that the LLC would be organized to engage in the practice of law, and that the LLC would not be organized for any federal income tax avoidance motive. Thus, the IRS ruled that the law firm could retain the cash method of accounting after it converted to an LLC. In Priv. Ltr. Rul. 9415005 (Jan. 10, 1994), the IRS also allowed a law firm converting into an LLC to retain the cash method of accounting, but did not base the ruling on the members' active participation in firm management activities. The IRS found that for purposes of Code 461 (i)(3)(A), the law firm would not be an enterprise so long as it did not offer interests in itself for sale in any offering required to be registered. The IRS also found that the LLC would not be a syndicate, although no representations were included in the ruling concerning management or the active participation of members; however, based on representations that the firm consistently reported taxable income rather than a loss, the IRS ruled that the LLC would not be a syndicate for any year in which it does not incur losses. The IRS declined to determine whether the LLC would be a tax shelter as defined in Code 6662 (d)(2)(C)(ii), but did find that the LLC would not be treated as a tax shelter under that Code Section solely as a consequence of its organizational structure as an LLC. Self-Employment Tax In computing net earnings from self-employment, the distributive share of any item of income or loss of a limited partner (other than guaranteed payments) is excluded. This exclusion was added because of the concern that investors might use limited partnerships as a means to become insured for Social Security benefits, undermining the basic principle of the Social Security program that benefits are designed to partially replace lost earnings from work. Thus, if all LLC members are treated as limited partners, regardless of participation in the business, all of the LLC's income or loss would be excluded from self-employment tax. In subsequent responses to criticism from various commentators, the Service publicly acknowledged that the solution contained in the Proposed Regulations was too formalistic and would not be implemented. In response to this criticism, the Service has now proposed revised Proposed Regulations under 1402 (26 CFR Part 1 (http://www.law.corne ll.e du/jure e ka/inde x.php?doc=CFR&title =26&part=1&se c=unde fine d&ye ar=unde fine d) ) published in the Federal Register on

January 13, 1997. The new Proposed Regulations would apply to all entities taxable as partnerships (not only LLCs, but also LLPs, LLLPs and General Partnerships). The general rule under the new Proposed Regulations is that an individual be treated as a limited partner unless (1) that person have personal liability as defined in Regs. 301.7701-3(b)(2)(ii); (2) has authority to contract under the applicable statute or law on behalf of the entity; or (3) participates in the partnerships trade or business for more than 500 hours per year. For professional firms (i.e. law, medicine, engineering and other firms traditionally _____________ as the professional firms) any distributable income will be subject to self-employment income tax. Perhaps most important under the Proposed Regulations, however, they do permit the bifurcation of interest as between a interest which would be characterized as limited partner interest and a general partner interest. Accordingly, it is now possible to properly structure, particularly if the service partner member is compensated using a guaranteed payment format, to bifurcate that portion of the interest which is attributable to the service interest and separate that from the financial interest, thus permitting the distributions with respect to the financial interest to qualify as not self-employment income. The ___________ to Proposed Regulations also acknowledges that logically these rules are still inconsistent with other pass-through entities, with notably S corporations. However, the Service reached the conclusion that it was beyond the scope of the regulatory project to correct these disparities. Accordingly, this is one area where an S corporation continues to enjoy slight benefits in the Service firm situation, enabling owners to withdraw some of the net profits as S corporation dividends which are subject to self-employment income tax. State Tax Considerations An area of increasing importance for planning in the use of LLC's is state tax characterization. Although most states treat LLC's for state tax purposes the same as for federal purposes, there are notable exceptions. For example, Florida subjects LLC's to its Florida corporate tax while Texas applies its corporate franchise tax to LLC's. Similarly, as number of states now impose entity level withholding on distributions to non-resident owners of LLCs, see, e.g. O.C.G.A. 48-7-129. Tax Considerations for LLPs As discussed in Chapter One of Part Two, an LLP is a general partnership that records a limited liability partnership election. The principal difference between a Georgia general partnership that is an LLP and one that is not, is that a partner in a LLP is liable only for such partner's own errors, omissions, negligence, malpractice, wrongful acts, incompetence or misconduct. A Georgia LLP will lack continuity of life because it will be dissolved "[b]y the express will or withdrawal of any partner . . .", and this cannot be varied by agreement. A Georgia LLP should also lack centralized management. In most situations a general partnership will also lack free transferability of interests, although this can be modified by agreement. A Georgia LLP would appear to possess a modified form of the corporate characteristic of limited liability since each partner is liable for his or her own errors, omissions, negligence, malpractice, wrongful acts, incompetence and misconduct. The IRS takes the position that this will not be enough for the partnership to lack limited liability. Thus, a Georgia LLP should always be classified as a partnership for federal tax purposes. Other Tax Issues Most of the partnership tax rules discussed above will apply to LLPs in the same manner that they apply to LLCs, with the possible exceptions of the passive activity rules and self-employment tax. Concerning the passive activity rules, while an LLC interest arguably would be limited partnership, interest for purposes of the material participation test, because the liability of a partner in a Georgia LLP is not limited to a determinable fixed amount, there is a substantial argument to the contrary. With respect to self-employment tax, Code 1402(a) provides that "net earnings from self-employment" include an 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 he is a member. . . ." Code 1402(a)(13) excludes from the definition of net earnings from self-employment the distributive share of any item of income or loss of a limited partner, other than guaranteed payments under Code 707(c). Thus, a limited partner will not be subject to self-employment tax. Under the proposed Regulations, it appears possible that a partner in a Georgia LLP could be considered to be a limited partner for purposes of the self-employment tax. The proposed Regulations provide that a member of an LLC will be treated as a limited partner if the three tests contained therein are met. A member is any person who owns an interest in an LLC, and an LLC is defined as an organization formed under a law that allows limitation of the liability of all members for the organization's debts and other obligations within the meaning of Regulation 301.7701-2(d), and is classified as a partnership for federal tax purposes. It appears that the IRS's position is that an LLP will have limited liability under Regulation 301.7701-2(d). Thus, because an LLP will be treated as a partnership for federal tax purposes, and a partner meets the three tests contained in the proposed Regulations, it is possible that partners will be treated as a limited partner for self-employment tax purposes.

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