¹See Paul B. Ding, 200 F3d 587 (9th Cir. 1999).

²Regardless of the SE tax, however, an S corporation may still not be an acceptable business form for income tax purposes. A partnership or limited liability company (LLC) may provide owners with higher basis, allowing greater loss deductions when an entity has debt. This is discussed in detail in Part II of this article, in the Nov. 2002 issue.

³Not every item of a general partner’s (GP’s) “distributive share” (as defined in Sec. 702) is taken into account for SE tax purposes. Usually, only a GP’s distributive share of net ordinary nonseparately stated income or loss (with adjustments), plus any guaranteed payments for services, are subject to SE tax. See Sec. 1402(a), flush language; see also the instructions for Form 1065, U.S. Return of Partnership Income, line 15, and the SE tax worksheet.

⁴An LLC owned by a single individual is disregarded for Federal tax purposes and is treated as a sole proprietorship; see Regs. Sec. 301.7701-3(a) and (b)(1)(ii). Thus, a sole member-owner of an LLC has limited liability protection. A sole proprietorship loss can reduce the member’s SE tax from another source; see Sec. 1402(a). A limited partnership with a corporate GP would also have limited liability, but the LPs’ distributive shares of losses would not affect SE tax liability; see Sec. 1402(a)(13).

⁵For example, Cal. Corp. Code Section 17101 provides that an LLC member is not personally liable for any of the LLC’s contracts, torts or other obligations by virtue of being a member.

⁶For example, Cal. Corp. Code Sections 17150 and 17158 provide that LLC members can manage, and persons acting as managers are not liable for any of the LLC’s contracts, torts or other obligations by virtue of being a manager.

⁷See Sec. 1402(a)(13). Although an LP’s distributive share does not have SE tax consequences, a guaranteed payment (defined in Sec. 707(c)) to an LP for services rendered is subject to SE tax.

⁸However, as discussed in Part II of this article, a member may have to increase his or her personal liability to include LLC debt as an at-risk amount.

⁹See Form 8832, Entity Classification Election, and the instructions.

¹⁰But see note 7, supra.

¹¹REG-209824-96 (1/13/97).

¹²The proposed regulation may treat an LP working in a business as a GP for SE tax purposes, even though the partner is an LP under state limited partnership acts. The unanswered question is whether Treasury exceeded its regulatory authority in light of Sec. 1402(a)(13), which states that an LP’s distributive share is not subject to SE tax. See ABA Tax Section Proposes Statutory Amendments Regarding the Application of the Self-Employment Tax, available at http://www.abanet.org/tax/pubpolicy/1999/7699b.html.

¹³See id., which argues that the proposed regulation’s premise of distinguishing between LPs and GPs is less sound than a premise that distinguishes between income from capital and income from services.

¹⁴Treasury has had time to withdraw the proposed regulation, but has not done so. The instructions to 2001 Form 1065 and Schedule K-1 do not provide much guidance. However, they each state, at p. 2: “Some members of other entities, such as…limited liability companies that are classified as partnerships, may be treated as limited partners for certain purposes.” [Emphasis added.] From this language, the IRS contemplates that LLC members can be GPs or LPs for different purposes.

¹⁵A “service partner” (service LLC member) is one who provides more than a de minimis amount of services to or on behalf of a service partnership’s trade or business. A “service partnership” is one in which substantially all the LLC’s activities involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science or consulting; see Prop. Regs. Sec. 1.1402(a)-2(h)(6)(ii) and (iii).

¹⁶A member may choose to guarantee a specific LLC obligation to obtain a larger loss deduction, by increasing his or her at-risk amount (as discussed in Part II of this article). This type of guarantee should not “switch” the LLC member from LP to GP status under #1 listed. The member is not personally liable by reason of being a partner, but rather, by reason of guaranteeing an otherwise nonrecourse debt.

¹⁷If B also held a nonmanagerial “class of interest,” the allocation related to that class might be treated as an LP allocation and not have SE tax consequences, according to Prop. Regs. Sec. 1.1402(a)-2(h)(3).

¹⁸See Prop. Regs. Sec. 1.1402(a)-2(h)(2)(iii). Prop. Regs. Sec. 1.1402(a)-2(h)(4) does not apply.

¹⁹An LLC could have different classes of interest if a member’s specific rights and obligations are different from another member’s specific rights and obligations. An individual may hold more than one class; however, the right to a guaranteed payment by a member does not, by itself, create another class, under Prop. Regs. Sec. 1.402(a)-2(h)(6)(i).

²⁰Prop. Regs. Sec. 1.1402(a)-2(h)(4). A “substantial” interest is based on all the facts and circumstances; however, ownership of 20% or more of a specific class is deemed substantial; see Prop. Regs. Sec. 1.1402(a)-2(h)(6)(iv).