LLCs and S Corporations: Mitigating Self-Employment Tax for Flow-Through Entities

This course will assist tax professionals in determining whether flow-through income should be subject to self-employment tax. Our veteran pass-through entity panelist will explain how reasonable compensation, payments to partners, and management authority status affect whether an owner's distributive share of income from a pass-through entity is subject to self-employment tax. He will examine how recent cases impact self-employment tax and limited partners.

Tax advisers struggle with whether a partner's or member's distributive share of income is subject to self-employment tax. In Soroban Capital Partners L.P. et al. v. Commissioner, 161 T.C. No. 12 (2023), the Tax Court sided with the IRS. It ruled that determining whether a partner is a limited partner, and therefore subject to self-employment tax, should be based on the limited partner's level of activity in the partnership. Recent court decisions, including Denham Capital Management L.P. v. Commissioner (T.C. Memo. 2024-114), have aligned with the Soroban decision.

Tax advisers often reflexively recommend electing S corporation status solely to mitigate self-employment tax. Before making such an election, tax advisers and their clients need to carefully weigh the potential disadvantages of S corporation status against a realistic estimate of the potential self-employment tax savings and against alternative structures and reporting positions that would allow the LLC members or partners to avoid self-employment tax on their distributive share income.

Listen as our self-employment tax expert explains, based on current law and recent cases, what income from flow-through entities can be reported as exempt from self-employment income and the implications for structuring and classifying business entities. The panel will also highlight possible legislative changes on the horizon.