Question

Shannon Hunter and two of her friends from UGA Law School recently formed a limited liability partnership (LLP) called Hunter and Associates. The three partners will split the income equally. The partnership will represent clients in bankruptcy and foreclosure matters. While some of Shannon’s attorney friends have suggested that the partners’ earnings will be self-employment income, some other colleagues they know from their local bar association meetings claim just the opposite. After examining relevant authority, explain how you would advise Hunter and Associates on this matter? {Hint: See §1402(a)(13) and Renkemeyer, Campbell & Weaver LLP v. Commissioner, 136 T.C. 137 (2011)} Prepare a memo analyzing the issue based on the relevant authorities you find. Document the conclusion to the issue based on your research and analysis.

Answer 1

As held in the case of RENKEMEYER, CAMPBELL & WEAVER, LLP, TROY RENKEMEYER, TAX MATTERS PARTNER, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT simultaneously read with section 1402(a) & 702(a)(8) the partners' earning will be self employement income.

Explanation: -

Section 1402(a) defines net earnings from self-employment as - the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business, plus his distributive share (whether or not distributed) of income or loss described in section 702(a)(8) from any trade or business carried on by a partnership of which he is a member.

Section 702(a)(8) provides that in determining his income tax, each partner shall take into account separately his distributive share of the partnership’s taxable income or loss, exclusive of items requiring separate computation under other paragraphs of section 702(a). Therefore, in general, a partner must include his distributive share of partnership income in calculating his net earnings from self-employment. Fees for services, like those generated by a law partnership, are part of the partners’ distributive shares under section 702(a)(8). Consequently, such fees are generally included in calculating net earnings from self-employment, unless an exclusion applies.

The case is reproduced below -

P is the tax matters partner of a Kansas limited liability partnership engaged in the practice of law. For the law firm’s tax year ended Apr. 30, 2004, three of the law firm’s partners were attorneys performing legal services. The fourth partner was an S corporation owned by a tax-exempt ESOP whose beneficiaries were the law firm’s three attorney partners. For tax year ended Apr. 30, 2005, the law firm’s only partners were the three attorneys. For tax year ended Apr. 30, 2004, the three attorney partners each had a one-third capital interest and a 30-percent profits and loss interest in the law firm. The S corporation had a 10-percent profits and loss interest in the law firm. Approximately 99 percent of the law firm’s net business income for its tax year ended Apr. 30, 2004, was derived from legal services rendered by the three attorney partners. For tax year ended Apr. 30, 2004, the law firm allocated 87.557 percent of its net business income to the S corporation. R determined that the special allocation did not reflect economic reality and consequently reallocated the law firm’s net business income to its partners on the basis of each partner’s profits and loss interest. R further determined that the three attorney partners’ distributive shares of the law firm’s net business income for tax year ended Apr. 30, 2004, and tax year ended Apr. 30, 2005, were net earnings from self-employment subject to tax on self-employment income. Held: R’s reallocation of the law firm’s net business income for its tax year ended Apr. 30, 2004, is sustained. Held, further, the law firm’s three attorney partners’ distributive shares of the law firm’s net business income for its tax years ended Apr. 30, 2004 and 2005, are subject to the tax on self-employment income.