Recently, the Internal Revenue Service (“IRS”) released an Advice Memorandum, addressing whether members of a Limited Liability Company (LLC), which acted as a management company (the “Management Company”) can be treated as limited partners for purposes of the Self-employment Tax (“SeT”), when such partners perform “extensive services” for the company. The Advice is significant because the application of said tax to LLC’s distributions has been unsettled for years.

The IRS rejected the Management Company’s position relying on legislative history and two recent judicial decisions. The legislative history indicates that the purpose of the limited partner exception is to exclude from taxable wages earnings that are of an investment nature. In the first decision, the court held that partners of a law partnership are not Limited Partners because the lawyers received income based on the legal services performed on behalf of the firm. In the second decision, members of an LLC subjected to SeT only the share of company’s income received as compensation (excluding the rest). The court concluded that because the members actively participated in the company business, all of their income was subject to SeT.
In its Advice, the IRS applied these decisions to the Management Company, observing that its members performed extensive services soall the LLC earnings were not of an investment nature and the members were not to be treated as “Limited Partners” for purposes of the SeT exemption.