Do Partnerships Pay Self-Employment Tax?
Unpack self-employment tax for partners. Understand your individual obligations on partnership earnings and how to accurately report them.
A partnership is a business structure involving two or more individuals or entities who agree to share in the profits or losses of a business. These are “pass-through” entities, meaning the business itself does not pay federal income tax. Instead, income, deductions, credits, and other tax items pass through to the individual partners, who report these on their personal tax returns. This contrasts with corporations, which can be subject to a separate layer of taxation.
Self-employment tax is an important consideration for individuals earning business income. This tax funds Social Security and Medicare, providing benefits like retirement, disability, and hospital insurance. Similar to taxes withheld from an employee’s wages, it applies to individuals who work for themselves. Understanding how these taxes apply to partnership income is essential for partners to fulfill their tax obligations.
Self-Employment Tax and Partnership Income
Partnerships do not pay self-employment tax. The responsibility for this tax falls on individual partners. This tax comprises Social Security and Medicare taxes, which fund federal social insurance programs. The total self-employment tax rate is 15.3%, consisting of 12.4% for Social Security and 2.9% for Medicare.
The Social Security portion applies to net earnings from self-employment up to an annual limit, which for 2024 is $168,600. There is no income limit for the Medicare portion; it applies to all net earnings from self-employment. For general partners, both their distributive share of the partnership’s ordinary business income and any guaranteed payments for services are subject to self-employment tax. Guaranteed payments are payments made to a partner regardless of the partnership’s income, often for services rendered or capital provided, and are treated as self-employment income.
Determining Net Earnings from Self-Employment
Calculating net earnings from self-employment is an important step for partners to determine their self-employment tax liability. For a general partner, net earnings from self-employment include their distributive share of the partnership’s trade or business income or loss. This share is determined by the partnership agreement and is reported to the partner regardless of whether it is actually distributed.
Guaranteed payments a partner receives for services provided to the partnership are also included in their net earnings from self-employment. To arrive at this figure, the gross income from the trade or business, including both the distributive share and guaranteed payments, is reduced by allowable business deductions at the partnership level. The resulting amount is then multiplied by 92.35% to determine the portion subject to self-employment tax, allowing for a deduction equivalent to the employer’s share of FICA taxes.
Reporting Self-Employment Income and Paying Estimated Taxes
Partners receive a Schedule K-1 (Form 1065) from the partnership, detailing their share of income, deductions, credits, and other items. This form provides information for partners to report their partnership activity on their individual tax returns. The net earnings from self-employment, derived from the Schedule K-1, are then used to complete IRS Schedule SE (Form 1040).
Schedule SE is designed to calculate the self-employment tax owed by self-employed individuals, including partners. If a partner’s net earnings from self-employment are $400 or more, they are required to file Schedule SE.
Since partnership income is not subject to tax withholding, partners are required to pay estimated taxes throughout the year. These payments cover both self-employment tax and income tax liability. Estimated tax payments are due in four quarterly installments: April 15, June 15, September 15, and January 15 of the following year. Failing to pay enough tax through these payments can result in penalties.
Special Considerations for Partners
The treatment of self-employment tax can vary depending on a partner’s role and the partnership structure. For instance, the distributive share of partnership income for a limited partner is not subject to self-employment tax. However, if a limited partner receives guaranteed payments for services, those payments are subject to self-employment tax. Recent tax court rulings emphasize a “functional analysis test” to determine if a limited partner’s role warrants self-employment tax on their distributive share, especially if actively involved in management.
Members of a Limited Liability Company (LLC) taxed as a partnership are treated as partners for federal income tax purposes. Their self-employment tax treatment depends on their involvement in the LLC’s trade or business. Active members are subject to self-employment tax on their distributive share of income, similar to general partners. Conversely, LLC members who are passive investors may qualify for the limited partner exception.
Self-employed individuals, including partners, can deduct one-half of their self-employment taxes paid when calculating their adjusted gross income on Form 1040. This deduction helps offset the burden of paying both the employer and employee portions of Social Security and Medicare taxes.