Could a single-owner LLC deduct the owner's one-half self-employment-tax deduction when computing taxable earned surplus?

Plain-English summary

A single-owner LLC could not use the owner's federal deduction for one-half of self-employment tax in computing the LLC's taxable earned surplus.

The owner reported the LLC's business income federally as a sole proprietor on Schedule C, calculated self-employment tax on Schedule SE, and deducted one-half of that tax as an adjustment to individual adjusted gross income. The question was whether the deduction could reduce federal taxable income on Schedule B, line 19 of the Texas franchise-tax report.

The Comptroller said no. Texas Tax Code Sec. 171.001(a)(2) treated the LLC as a taxable entity even though federal law treated it as a conduit or pass-through. Rule 3.562(f) required a federally disregarded single-owner LLC to compute reportable federal taxable income using income and deductions that related to the LLC. The Section 164(f) deduction was allowed to the individual, not the LLC.

Currency note: This ruling applies the pre-2008 taxable-earned-surplus tax and its report forms. Texas replaced that regime with the margin tax effective January 1, 2008.

What this means for you

Owners of single-member LLCs

Federal disregarded-entity treatment did not make every owner-level deduction an entity-level deduction for the former Texas franchise tax.

Tax professionals

The key question was who owned the deduction. The self-employment-tax adjustment reduced the individual's adjusted gross income, while the Texas LLC calculation used items relating to the LLC itself.

Common questions

Q: Did federal sole-proprietor treatment control Texas entity status?
A: No. Texas treated the LLC as a taxable entity under Section 171.001(a)(2).

Q: Why was the self-employment-tax deduction denied?
A: Because Section 164(f) allowed it to the individual owner, not to the LLC.

Citations and references

• Texas Tax Code Sec. 171.001(a)(2)
• 34 Tex. Admin. Code Sec. 3.562(f)
• I.R.C. Sec. 164(f)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9812595L

Original ruling text

December 16, 1998

Dear Mr. **:

In your e-mail you inquired about the treatment of the deduction for self
employment tax in computing taxable earned surplus for a limited liability
company (LLC) which is treated as a sole proprietorship for federal income tax
purposes.

The deduction for self employment tax is not allowed in computing federal
taxable income on Schedule B, line 19 of the franchise tax report. Under Texas
Tax Code Sec. 171.001(a)(2), the LLC is a taxable entity contrary to its
general treatment under the Internal Revenue Code (IRC) as a conduit or pass
through entity. As indicated in Rule 3.562(f), an LLC treated as a sole
proprietorship for federal income tax purposes computes reportable federal
taxable income using the income and deduction items which relate to the LLC.
The deduction for self employment tax under IRC Sec. 164(f) is only allowed to
individuals as a deduction in computing adjusted gross income. Thus, the
deduction pertains to the individual, not the LLC.

If you have questions about this, my Internet address is
[email protected], or you may call me toll free at 1-800-531-5441,
extension 3-4662.

Sincerely,

Bob Jeffcoat
Tax Policy Division

On Mon, 30 Nov 1998 11:04:09 -0600 ** wrote:

Hello,

I have a question regarding an individual who formed an LLC and is reporting
his business income to the IRS as a sole porprietor on Sch C of Form 1040.

That Sch C net income figure is then brought to Sch SE (Self-Employment Tax),
where the SE Tax is calculated and a deduction for 1/2 of SE Tax is then
carried forward to Pg 1 of the 1040 as an adjustment to AGI, and therefore
ultimately to Taxable Income.

My question is this: is the 1/2 SE tax allowed as a deduction on Sch B -
Computation of Surtax on Net Taxable Earned Surplus? I was considering that it
could be via Line 19 of Sch B (Net Tax Earned Surplus) where it asks for the
Federal taxable income figure, since the 1/2 SE tax figure ultimately affects
Taxable Income on the 1040.

I sincerely appreciate your time and effort in this matter. If you require
additional information regarding this matter before you can fully address it,
please do not hesitate to email me ([email protected]) or call
(713-850-1096x108)

Thank you