8736 / Are partners and members of LLCs considered independent contractors or employees?
A general partner is treated as self-employed and income received from the partnership is, accordingly, treated as self-employment income.1 Income received by a limited partner, on the other hand, is generally not treated as self-employment income unless that income represents a guaranteed payment to the limited partner within the meaning of IRC Section 707(c).2 A payment will be considered “guaranteed” under Section 707(c) if it is made without regard to the income of the partnership.3
If an LLC is taxed as a partnership, its members are treated as partners for tax purposes (including determining whether their income represents self-employment income).4 Despite this, in the case of an LLC member, if a member who has contributed both services and capital to the organization receives a distribution, the distribution should represent self-employment income insofar as it relates to the services contributed by the member. The difficulty arises in determining whether a distribution relates to the services or a return of capital.
The Tax Court recently held that payments received by a taxpayer through his LLC were guaranteed payments, rather than partnership distributions, that gave rise to ordinary income tax liability because the payments were made without regard to the partnership’s income and were made in exchange for the taxpayer’s services, not as a return of partnership capital.