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Avoiding Self-Employment Tax with a Limited Partner Interest
The best tax planning will often be found where both the form and substance of a transaction align in the client’s interest. One such planning activity focuses on reducing self-employment tax, and while the attempt is admirable, the substance of the transaction might be stronger than its form. Generally, if you’re a partner in a partnership, your distributive share of income is subject to Self Employment Contributions Act (SECA) tax, also known as self-employment tax. This can be up to an additional 15.3 percent on your earnings, unless an exception applies. Many tax pros attempt to mitigate this tax by simply making the spouse of the main business partner a limited partner in the entity. The thought is that an exclusion applies for SECA tax when there is a “limited partner’s” share of partnership income. But be careful! When the underlying substance overrides the form of a transaction, the taxpayer generally will lose. The IRS recently highlighted such a problem with form in its draft partnership tax instructions by saying “For purposes of self-employment tax, however, status as a limited partner is determined under Section 1402(a)(13); whether a partner is a limited partner under state limited partnership law is not determinative.” Simply calling a partner “limited” is not enough. The limited partner exception from self-employment tax creates a significant benefit when applied, but rulings focused on the substance of the partner’s interest have narrowed this exception. Let’s review how to properly qualify as a limited partner in light of the IRS’s recent emphasis in this area. In the process, we will also look at the specifics of how particular forms should still win the day by avoiding SE tax. Keep reading for more.
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CURRENT EDITION
Editor’s Pick: Tax Planner Faces Malpractice Claims Over Decades-Old Tax Advice—What Went Wrong?
In a case that every tax professional should take note of, the prominent law firm Sidley Austin LLP finds itself defending against claims that it provided faulty tax advice over two decades ago, leading to massive IRS liabilities for a family. The plaintiffs, the Cáceres family, are seeking to recover $7 million after settling with the IRS, claiming Sidley’s advice on a complex asset liquidation set them up for disaster. The kicker? The lawsuit was filed over 25 years after the advice was given. So, how are the plaintiffs still able to pursue the case? It all boils down to a claim of fraud—and how that could toll the statute of limitations.
Navigating IRS Penalty Relief and Forgiveness
Yes, the IRS does forgive some tax penalties. The IRS refers to this forgiveness as penalty abatement. Abatement is the act or process of reducing or removing something. In this case it is removing or reducing a penalty. But penalty forgiveness is not a blanket offer that everyone qualifies for the way the radio ads make it seem. There is a process that the IRS has for requesting and granting abatement. It is up to the taxpayer to prove that they qualify for abatement. That’s where you come in.
From The Government And Not There To Help You
The story of James J. Maggard has some interesting and possibly valuable lessons. The one that strikes me as particularly important is that it makes it crystal clear that disproportionate distributions contrary to a corporation’s governing documents will not blow its S election. That does not mean that disproportionate distributions are just fine and that you don’t need to address them. There is a practical lesson about being careful who you take on as fellow shareholders. And there is another slightly odd lesson, that almost makes me want to create a new law of tax planning: Don’t deliberately involve the IRS in your business disputes. Their job is not to help you.
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Think Outside the Tax Box provides tax reduction strategies along with practical
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