LLCs, Partnerships and Self-employment Tax

Rhonda from NY asked a multi-part question a while ago. One part of her question was answered here I am an LLC. How do I pay taxes? And now that I've successfully met the October 15 deadline for a lot of slow-to-get-to-it clients I can answer the other part of her question.

Rhonda's situation and questions are:

I am starting an LLC in NY with 2 other members. I am the managing member and the other 2 will not participate in management issues.

I understand I am subject to self employment [SE] taxes and they are not, but is this done only after profits/losses are distributed?

If the business has no net income, does that mean I pay no self-employment taxes?

I hope I did this the right way in leaving this question here and not posting a comment on line to you answer. This is my first time doing something like this and I do not know the "proper" procedures.

Again, thank you for you help.
Rhonda ... Bronx, NY


In a typical partnership, several people with different complementary skills get together to form a business. Rhonda doesn't say what kind of business they have formed so let's make one up to facilitate my examples. Since there are so many IT folks out there, I'll give Rhonda an IT business.

If all three participate in this business then they are all general partners. If they are equal partners each will share in 1/3 of the loss or 1/3 of the profit of the partnership. If the partnership has gross income of $50,000 and expenses of $20,000 then each would have income of $10,000 subject to income tax and SE tax. If the partnership had no profit, then there is no income or SE tax liability.

Profit is another way of saying net income -- that's gross income minus expenses -- and each partner will receive a partnership K-1 at year-end stating income and whether it is subject to SE tax or not.

An alternate scenario has Rhonda as the only one with technical skills and the only one to work for the partnership. Only her income is subject to SE tax. Partner #2 did nothing for the business other than contribute money and partner #3 did nothing for the business other than contribute equipment. Their partnership income was taxable but not subject to SE tax.

To recap: Simply not being part of management does not make the other partners exempt from SE tax. Their relationship to the partnership must be limited. That means they do not work in the partnership. For their portion of the partnership profit they may do things such as:
** Put in money
** Contribute equipment
** Loan a name or reputation
** Perform a specific service -- not related to the nature of the business, for instance -- legal or accounting, or logo design for which they'd receive a Form 1099-MISC from the partnership.

One last note: Of course, Rhonda should not set up an LLC and form a partnership without guidance from her tax pro.

June Walker