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"Alternatively, if the LLC is manager-managed and has at least one passive investor-type member (participates less than 500 hours/year), you can allow the LLC to be taxed as a partnership (no form to file to get that treatment) and have the operating agreement provide for "investor" class interests and "manager" class interests in accordance with the Sec. 1402 Proposed Regulations issued a few years ago. The investor class interests will not be subject to self employment tax. Arguably you can avoid more SE tax this way than with an S corp, though I don't advise my clients to do so. The great advantage of doing it this way is that you get the SE tax treatment you want with all of the other good things about partnership tax treatment and without the limitations of an S corp."


I don't disagree with this but I don't think this strategy could be used in the scenario presented - a consulting business formed by two active consultants. If memory serves, individuals engaged in consulting activities are considered active participants, even if they don't meet the 500 hour requirement.

Also, I'm not sure what additional liability protection they would get from an LLC/S corp over and above a regular S corp. In my state (Pa.), there's a $50 per member per year fee imposed on LLCs.

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