Members of Diagnostic Imaging LLC Subject to Self-Employment Taxes

In Reither v. Commissioner, 112 AFTR2d 2013-6074 (D. N.M.), the court rejected on summary judgment a radiologist’s and his wife’s claim that they were not liable for self-employment tax on their distributive share of income from a diagnostic imaging LLC taxed as a partnership.  Although not clear from the facts of the case, presumably all of the income of the diagnostic imaging LLC was attributable to the “facility fee” or “technical component” of the imaging services provided by the LLC rather than for professional medical (reading) services.

The LLC actually issued W-2s to husband and wife showing salaries or wages paid by the LLC to each of them for a portion of the LLC’s income.  For the balance of the LLC’s income, K-1s were issued to husband and wife on which they did not pay self-employment tax.

Citing Rev. Rul. 69-184, the court stated that the LLC should have treated all of the LLC’s income as self-employment income, rather than characterizing some of it as wages.  Specifically, Rev. Rul. 69-184 states that members of a partnership are not employees of the partnership for purposes of self-employment taxes.  Rather, a partner who participates in the partnership business is “a self-employed individual.”  The court found that the LLC’s improper treatment of the “wage” incomes further undermined the taxpayers’ simplistic argument that they owed no self-employment taxes simply because they received W-2s.

The taxpayers also argued that the income of the LLC was “unearned income,” and as such, was not subject to the self-employment tax.  The court stated that simply labeling income as “unearned income” does not exempt such amounts from the self-employment tax.  Rather, the court reiterated that the self-employment tax applies to a taxpayer’s distributive share of all partnership income with only certain limited exceptions.  Citing Section 1402(a)(13), which exempts from the self-employment tax a limited partner’s distributive share of income from a limited partnership, and Renkemeyer v. Commissioner, 136 TC 137 (2011), the court concluded that the taxpayers were not members of a limited partnership, nor did they resemble limited partners, which are those who “lack management powers but enjoy immunity from liability for debts of the partnership.”  In Renkemeyer, the Tax Court disallowed a law firm’s special allocation of business income and held that the firm’s attorney partners were liable for self-employment tax on allocations of partnership income related to the law firm’s legal practice.  Thus, whether the taxpayers were active or passive in the production of the LLC’s earnings, those earnings were self-employment income, subject to the self-employment tax.

This case highlights the likelihood that income from an LLC taxed as a partnership will be subject to self-employment taxes, including the new 3.8% Medicare portion of the self-employment tax for higher income individuals.  If the business had been operated as an S corporation rather than an LLC taxed as a partnership, the dividend distributions made by the S corporation to its shareholders would have likely not been subject to the self-employment tax or to the Net Investment Income Tax imposed under Section 1411.