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Multimember LLC owners: Skirt the self-employment tax

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in Small Business Tax

If you and other co-owners operate your business as a multimember LLC, you may already know to file a partnership return on Form 1065. Each owner is treated as a partner for federal income tax purposes, so each receives a Schedule K-1 with his or her share of the LLC's 2003 business income, deductions and credits. You report those figures on your 2003 personal return.

Simple enough, but how do you as an LLC member figure your self-employment (SE) tax bill on Schedule SE? Good question. You'll like our answer, but first you need to understand the background:

Limited partners pay limited SE tax. Honest-to-goodness partners must pay SE tax on their shares of partnership business income unless they are limited partners. Limited partners owe SE tax only on salaries from the partnership for services rendered. (Technically, partner salaries are called "guaranteed payments" in tax lingo.)

Here's where it gets interesting: You can make a strong argument that LLC members, like you and your fellow co-owners, should be considered limited partners for SE tax purposes, because none of you are personally liable for the LLC's debts under state law.

So you can argue that you owe no 2003 SE tax on your share of the LLC's business income, except the SE tax due on your salary for services rendered to the firm. If you simply received payouts from time to time when cash was available, that doesn't seem to fit the description of a salary.

Strategy: Consider omitting any LLC income (other than your salary) from your SE tax calculation on Schedule SE. Depending on your share of the income, you could save thousands of dollars.

Be advised: The IRS doesn't like that position, and the issue will probably land in court unless Congress passes clarifying legislation. If you're audited, the IRS is likely to challenge your stand. For now, however, that strategy is within the bounds of the law, and the IRS is not pressing the issue. Still, consult with your tax adviser on the question before filing a return that takes such an aggressive position. That said, nothing ventured, nothing gained.

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