Important Recent Tax Developments: Self-Employment Taxes and LLC Members

by Gregory L. White, CPA | Aug 04, 2017

Under a direct ownership structure, The Tax Court has issued two recent cases involving the imposition of self-employment taxes on LLC and PLLC members: Stephen P. Hardy v. Commissioner1 and Vincent Castigliola v. Commissioner2. These cases shed additional light on this evolving area and also suggest planning opportunities.

New Cases

Stephen Hardy is a plastic surgeon who works in Missoula, Montana. In addition to his professional practice, Dr. Hardy owns a 12.5% interest in a surgical center where he performs some of his surgeries. His case involved application of self-employment tax to the earnings from the surgical center.

Dr. Hardy had very little involvement in the surgical center, other than performing periodic surgeries at the center (through his separate company—he didn’t contract with the surgical center, nor were his surgeries performed on its behalf). His direct involvement was limited quarterly meetings with the other owners. He had never managed the center, and had no day-to-day management responsibilities or input on management decisions. The case doesn’t address whether the surgical center LLC was member-managed (i.e., all members have the power to act on behalf of the LLC) or manager-managed (the power to act is vested in specific persons).

Vincent Castigliola is an attorney who practices in Pascagoula, Mississippi. He is a member of a law firm that operates as a PLLC. The PLLC is member-managed; all members have the power to act on behalf of the PLLC. He provides all of his legal services through the PLLC and the revenues of the law firm are derived from legal services. He also actively participates in the control of the PLLC.


Dr. Hardy’s distributive share of income (Form K-1, Line 1) wasn’t subject to self-employment tax. In making its determination, the Tax Court cited its prior decision in Renkemeyer v. Commissioner3. The Renkemeyer decision was based upon the legislative history under §1402(a)(13) (which provides that Congress’ intention was not to impose self-employment tax on limited partners where the earnings are basically investment in nature).

Vincent Castigliola’s distributive share of income from the law firm PLLC was held to be subject to self-employment tax. Perhaps this is unsurprising, but the apparent basis for these holdings has caused concern.

The Issue: Power to Manage vs. Actual Amount of Services Provided

The Hardy case focused on the actual amount of services that Dr. Hardy provided. The case didn’t discuss whether he had the power to act on behalf of the LLC, i.e., whether it was member-managed, or if he was a manager.

In contrast, in Castigliola, the Tax Court focused both on Vincent’s power to act (he was a member-manager) and also the amount of services he provided. This is troublesome, because the precise basis for the court’s holding isn’t apparent. Did the Tax Court imply that the mere power to act results in self-employment tax? This was the holding in an earlier district court case, Riether v. U.S4.

Are LLCs Different from PLLCs and LLPs?

The Hardy case makes an interesting distinction—it holds that an LLC is distinguishable from an LLP. This suggests that professional service entities will be treated differently from other types of entities. Taxpayers have lost both cases involving professional service entities (in one case, Renkemeyer, an LLP, in the other, Castigliola, a PLLC). Perhaps this is not surprising.

So, Which Is It? Does Possessing the Mere Power to Act Result in Self-Employment Tax?

Renkemeyer noted that limited partners (who aren’t subject to self-employment tax) typically lack the “power to act.” However, the court based its decision on the actual amount of services provided by the member, not the mere power to act. Castigliola clouds the issue by discussing both the “power to act” and the amount of services provided.

Hardy addressed only the amount of services, not whether Dr. Hardy had the “power to act.

Riether, however, indicated that mere “power” to manage is sufficient to result in an LLC member’s treatment as a general partner, and thus subject to self-employment tax.

Weighing the Authority

Riether, the worst case for taxpayers, is a district court case. Renkemeyer is a “regular” decision of the Tax Court, and as such has greater authority. Hardy and Castigliola are memorandum decisions, which hold considerably less authority.

The Tax Court’s decisions are generally accorded greater weight than other court’s decisions, due to the Tax Court special expertise. Further, it is the most common jurisdiction for taxpayers. Therefore, the standard established in Renkemeyer remains the best guidance; the key to determining the application of self-employment tax is the amount of services actually provided, not the member’s “power to act.

So What Should Tax Practitioners Do?

I believe that there’s substantial authority for LLC members in member-managed LLCs to avoid self-employment tax if they have minimal involvement in the operation of the LLC.

However, cautious practitioners may wish to convert LLCs from member-managed to manager-managed—and make sure that the investors in the LLC are not managers. This is undoubtedly a safer approach.

Greg-White headshot

Gregory White, CPA, is an Adjunct Professor at Golden Gate University and founder of WGN, PS in Seattle.

1 TC Memo 2017-16
2 TC Memo 2017-62
3 136 T.C. 137.
4 919 F. Supp. 2d 1140 (DC NM)

This article appeared in the summer 2017 issue of the WashingtonCPA Magazine. Read more here.

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