How Revenue Ruling 2012-18 Impacts Self-Employment Tax

The Internal Revenue Service (IRS) provides guidance on how certain payments made from a partnership to its partners are treated for tax purposes. A primary area of focus is whether these payments are subject to self-employment tax. This is particularly important for a type of payment known as a guaranteed payment, which partners receive for services they provide to the partnership.

Understanding Guaranteed Payments and Self-Employment Tax

A guaranteed payment is a payment made by a partnership to a partner for services rendered or for the use of capital. A feature of these payments is that they are determined without regard to the partnership’s income. In simpler terms, a partner receives this payment regardless of whether the partnership makes a profit or incurs a loss.

Self-employment tax is a tax consisting of Social Security and Medicare taxes for individuals who work for themselves. It is analogous to the Federal Insurance Contributions Act (FICA) taxes that are withheld from the paychecks of most wage earners. For 2025, the self-employment tax rate is 15.3%, broken down into 12.4% for Social Security on the first $176,100 of earnings and 2.9% for Medicare with no income limit.

Tax Treatment of Guaranteed Payments

Guaranteed payments made to a partner for services rendered to the partnership are subject to self-employment tax. The reasoning is that such payments are considered net earnings from self-employment under Internal Revenue Code Section 1402. Because partners are not considered employees of the partnership for federal tax purposes, these earnings are treated as self-employment income. Since the guaranteed payments are for services rendered, they are functionally the same as a salary. This rule prevents partners from recharacterizing what is compensation for labor as a distribution of partnership profit to avoid self-employment tax.

Application to Limited Partners and LLC Members

A limited partner’s distributive share of partnership income is excluded from self-employment tax. This exclusion exists because limited partners are passive investors who do not actively participate in the business. However, this exemption does not extend to guaranteed payments received for services, which are subject to self-employment tax.

For members of a Limited Liability Company (LLC) that is taxed as a partnership, the IRS treats LLC members who are active in the business as general partners for self-employment tax purposes. This means that their distributive share of the LLC’s business income and any guaranteed payments they receive for services are included in their net earnings from self-employment. The limited partner exception is not available to LLC members who participate in the business for more than 500 hours during the year or have personal liability for the LLC’s debts.

Tax Reporting and Compliance

The proper reporting of guaranteed payments is a two-step process involving both the partnership and the individual partner. The partnership must first report these payments on its annual tax filing, Form 1065, U.S. Return of Partnership Income. The total amount of guaranteed payments made to all partners is deducted as a business expense on the front page of Form 1065, which reduces the partnership’s ordinary business income.

From there, the partnership allocates and reports each partner’s specific share of items on Schedule K-1 (Form 1065). Guaranteed payments for services are specifically reported in Box 4a of the Schedule K-1. This document is provided to each partner and a copy is filed with the IRS.

The individual partner uses the information from their Schedule K-1 to complete their personal income tax return, Form 1040. The amount of guaranteed payments from Box 4a of the K-1 is carried over to Schedule SE (Form 1040), Self-Employment Tax. On Schedule SE, the partner calculates the amount of self-employment tax owed. The calculated tax is then added to the partner’s total income tax liability on Form 1040.