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Editorial 11 MIN READ

LLPs and LLLPs in mid-2020: a form built for a city that emptied out

Remote work tests the state-licensing tie, the final §199A regs did not rescue SSTB partners, and Renkemeyer still decides the self-employment question

The Editors
Staff, Incorporator.org
11 min read Updated
Contents 6 sections
  1. What the remote quarter did to the state-licensing tie
  2. Final §199A regulations: T.D. 9847 and the SSTB definitions that stuck
  3. Self-employment tax: Renkemeyer, and then nothing
  4. The LLP vs. check-the-box analysis the §199A arithmetic keeps raising
  5. The net position in June 2020
  6. Sources

wenty months ago we said the tax code had done more to the LLP in 11 months than any state legislature had in a decade. Since then Treasury finalized the §199A regulations, the IRS kept winning Renkemeyer-shaped self-employment cases, and every LLP with a physical office spent the second quarter of 2020 running its practice out of partners' spare bedrooms. The wrapper held. The assumptions underneath it bent.

This is a field report on the limited liability partnership and the limited liability limited partnership as of June 2020, updating the March 2017 piece and the November 2018 revisit. The RUPA § 1001 mechanics have not moved. The operating environment has.

What the remote quarter did to the state-licensing tie

The LLP was designed around a partnership with an office. California Corp. Code § 16101 is explicit about it: a registered LLP in California must be a partnership each of whose partners is licensed in one of five professions, and the firm must be "engaged in the practice of a profession" that state law authorizes only through that license. The professional-licensing statutes in every large state embed the same assumption. A California attorney practices California law in California. A New York CPA practices New York accounting in New York. The LLP is a wrapper around a licensed practice conducted in the licensing state.

Between March 16 and March 22, 2020, every large-city professional services firm in the country sent its lawyers, accountants, and consultants home. "Home" was frequently not the licensing state. A New York LLP with a Manhattan lease had partners riding out the lockdown at summer houses in Connecticut, Vermont, and Florida. A California LLP's junior associates worked from parents' houses in Oregon, Arizona, and Washington. The wrapper the LLP assumes, a licensed practitioner inside the licensing jurisdiction, broke for a quarter and, for many firms, has not returned.

The state bars responded through emergency rules on the unauthorized practice of law, most of them derived from ABA Model Rule 5.5, under which a lawyer can temporarily practice in a non-licensing state on a client matter substantially related to a licensing-state practice. The state accounting boards issued parallel relief. None of the emergency orders touch the entity-law question. A California LLP whose partners are all California-licensed attorneys still files as a California LLP under Corp. Code § 16101 regardless of where the partners have been physically working since March. The § 16101 test reads to the partners' licensing, not their street address. A partnership that keeps its partners licensed in California remains a California LLP even if the partnership operated entirely from out-of-state residences for the quarter.

Where this gets interesting is foreign qualification. A New York LLP whose partners spent the quarter working from Florida vacation homes is generally not "doing business" in Florida for foreign-qualification purposes solely on the basis of a partner's remote presence during a declared emergency. The Florida Department of State has not pressed the position. The New York Department of State has said nothing. But the underlying question, whether an LLP doing its work from twenty states simultaneously needs to register in each, is the first-order question the next two years of state-law litigation will work through. The old rule of thumb, that an LLP registers where it has an office and where it is holding itself out, is going to get tested by a partnership that has neither.

The narrower, practical point: an LLP with employees who relocated across state lines during Q2 almost certainly picked up payroll-tax obligations in those employees' new states. The partnership side of the return follows the firm's offices; payroll follows the worker. Firms that spent March figuring out how to get a Zoom account issued are figuring out in June what they owe to five new state tax authorities.

Final §199A regulations: T.D. 9847 and the SSTB definitions that stuck

Treasury finalized the §199A regulations in T.D. 9847, published in the Federal Register on February 8, 2019 (84 Fed. Reg. 2952). The final regulations largely adopted the proposed-reg framework from August 2018 that our 2018 revisit walked through. For an LLP partner reading them in 2020, three things matter.

First, the specified service trade or business definitions at Reg. § 1.199A-5(b)(2) did not soften. "Law" is defined as the services of lawyers, paralegals, legal arbitrators, mediators, and similar professionals performing services in their capacity as such. "Services in the field of accounting" covers the provision of accounting services to clients, including tax return preparation, accounting, auditing, and bookkeeping, without the CPA-license limitation some commenters argued for. "Consulting" is the provision of professional advice and counsel to clients to assist the client in achieving goals and solving problems. The categories are broad, and they cover the work a partner in a law, accounting, or consulting LLP actually performs.

Second, the reputation-or-skill catch-all that Treasury signaled in August 2018 would be narrowed did get narrowed. The final reg limits the catch-all to three situations: receiving fees, compensation, or other income for endorsing products or services; licensing or receiving fees for the use of an individual's image, likeness, name, signature, voice, or trademark; and receiving fees for appearing at events or on media. This is effectively a celebrity-income category. A partnership is not an SSTB under the catch-all because its partners are good at what they do. It is an SSTB if it falls within one of the enumerated fields.

Third, the de minimis rule at Reg. § 1.199A-5(c)(1) carried forward from the proposed regs: a trade or business with 10% or less of gross receipts from SSTB activity (5% for gross receipts over $25 million) can ignore the SSTB taint. The final regs also adopted an anti-abuse rule at Reg. § 1.199A-5(c)(2) that treats an SSTB activity and a non-SSTB activity as a single SSTB if the non-SSTB was spun out and has 50% or more common ownership with the SSTB and shares expenses or provides substantially all property or services to the SSTB. The "crack and pack" strategy of spinning the firm's real estate or administrative services into a separate non-SSTB partnership that leases back to the law firm does not work.

The 2020 §199A(e) thresholds, adjusted for inflation, are $163,300 single and $326,600 joint, with the phase-out band running $50,000 single and $100,000 joint above those amounts. A senior partner in a law, accounting, or consulting LLP clears the joint ceiling easily on K-1 income alone. The §199A deduction, for that partner, is still zero. What T.D. 9847 did is confirm the position; it did not change it.

Self-employment tax: Renkemeyer, and then nothing

§ 1402(a)(13) carves limited partners out of self-employment tax on their distributive shares of partnership income, other than guaranteed payments for services. Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. 137 (2011), held that LLP partners who performed substantially all the services of a Kansas law firm were not "limited partners" for § 1402(a)(13) and owed SE tax on their full distributive shares. That holding is nine years old this spring. It is still the controlling authority.

Since our 2018 piece, the IRS has continued to litigate the issue on Renkemeyer's reasoning. There has been no contrary Tax Court decision. There has been no circuit-level reversal. Treasury has not issued proposed or final regulations on the § 1402(a)(13) definition of "limited partner"; the 1997 proposed regs under § 1.1402(a)-2 remain withdrawn in fact if not in form, and no project is on the Priority Guidance Plan. The agency's position, articulated in CCA 201436049 and restated in field advice since, is that a service partner's distributive share is SE income regardless of the state-law entity label.

The 2020 self-employment math for an LLP service partner looks like this. Social Security tax runs at 12.4% on the first $137,700 of net SE earnings (the 2020 Social Security wage base, set annually by the Social Security Administration under 42 U.S.C. § 430). Medicare tax runs at 2.9% on the full amount, with an additional 0.9% Medicare surtax under IRC § 1401(b)(2) on SE earnings above $200,000 single or $250,000 joint. The § 164(f) above-the-line deduction offsets half the Social Security and regular Medicare components. For a senior partner in a law or accounting LLP with $600,000 of K-1 ordinary income, the combined SE tax before offsets runs roughly $34,500 ($137,700 x 12.4% plus $600,000 x 2.9% plus $400,000 x 0.9%), subject to the § 164(f) adjustment and the reduction for the partner's portion of partnership guaranteed payments treated separately.

What 2020 added, on top of the background rule, is the CARES Act's § 2302 deferral. Any employer's share of Social Security tax owed on wages paid between March 27, 2020 and December 31, 2020 can be deferred, with 50% due December 31, 2021 and the balance due December 31, 2022. The deferral applies to 50% of a self-employed individual's § 1401 self-employment Social Security tax for the same period. An LLP partner can defer a material portion of the 2020 SE tax bill. The deferral is an accounting convenience, not forgiveness, and the partnership agreement has to handle which partner pays what when the two installments come due.

The LLP vs. check-the-box analysis the §199A arithmetic keeps raising

In 2018 we flagged that a law firm facing a 37% ordinary rate with no §199A deduction had, for the first time in a generation, a real C-corp conversion analysis. The rate differential between 37% ordinary and 21% corporate plus a qualified-dividend rate on distributions is roughly the margin that makes the analysis worth doing for a firm that does not distribute all its earnings.

Eighteen months later the conversion analysis is getting done and mostly not executed. The reasons are not tax reasons. Professional corporations in the five California § 16101 professions face state-bar rules on ownership, on profit participation, and on the permissible ownership of corporate shares in the practice. A California law firm that converts from LLP to PLLC or PC has to satisfy Corp. Code § 13403 and the parallel State Bar rules on professional corporation ownership, which require that all shareholders be licensed California attorneys and impose malpractice-insurance minimums. The tax benefit exists. The governance, licensing, and estate-planning costs of getting inside a professional-corporation structure usually exceed it.

The firms that have pulled the trigger are mostly boutique investment-management partnerships and some consulting firms where the ownership base is small, the licensing overlay is minimal, and the cash-retention story is strong. For a law firm or a Big Four local practice, the analysis keeps landing the same place: keep the LLP wrapper, designate a BBA partnership representative under IRC § 6223, pre-authorize the § 6226 push-out, and calendar the § 306(c) filing fees.

The net position in June 2020

A partnership considering an LLP election this quarter has the same RUPA § 1001 filing to make it had three years ago. The Texas fee at $200 per general partner under Tex. Bus. Orgs. Code § 152.806 is the same. The Delaware $200 statement-of-qualification filing plus the per-partner LLP tax and the $300 flat alternative-entity tax under 6 Del. C. § 15-1001 and § 17-214 is the same. California's $800 franchise tax under Form 565 is the same. The § 306(c) shield the election buys is the same.

What is different is the environment. The partnership is probably operating from fifteen locations. The partners above the §199A thresholds are not getting a 20% deduction if the firm does the kind of work LLPs were written for. The BBA regime is live and the partnership representative's authority has to be in the agreement. The SE tax calculation for service partners is Renkemeyer straight down the middle, with a CARES Act deferral overlay this year only. And the state-licensing tie that the LLP form quietly rested on for three decades is getting a stress test that no state bar or division of corporations has publicly resolved.

A service partnership forming in 2020 should still elect LLP status; the shield is worth what it has always been worth and the filing costs are a rounding error on any firm's first month of payroll. What has changed is what the election is silent about. A 1991 partnership could file the Texas statute and assume its lawyers would practice from the firm's office. A 2020 partnership files the same statute and has to figure out, in its partnership agreement and its engagement letters and its state tax returns, what it means to be a licensed firm whose licensed work happens everywhere.

Sources

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