From a legal perspective, there are no partners in an LLC, only owners -- who are called members. LLC members, in most cases, "must" claim business income as self-employment earnings. LLCs are "pass through" businesses, with all profits and losses treated as self-employment personal income or loss. However, there are a few options to treat LLC income differently.
Multi-Member LLCs Are Like Partnerships
LLCs with more than one member are automatically treated like partnerships. However, multi-member LLCs can choose to be taxed as partnerships or corporations. In most cases, however, all LLC income is treated as personal, self-employment income, without regard for a member's personal preferences. This is similar to classic partnership tax treatment.
Other Member Tax Options
LLCs, as entities of the state, not federal, government, must abide by individual state regulations. Absent other permitted modifications, members always receive LLC income as personal income, as if generated by self-employment. For federal income tax purposes, LLCs can elect to be treated corporations. They can choose to be taxed as C corps, with LLC profit distributed as dividends, or S corps, which act like LLCs as pass through companies with profits treated as earned income to members.
Why Partners Are Members
Although the term "partners" is not used, in a smaller LLC, the members are actually partners with other members. Because of the protection of limited liability, like that afforded owners of corporations, LLC members have much safer positions than partners, who are exposed to unlimited liability in a classic partnership. The hybrid business structure of an LLC -- somewhere between a partnership and a corporation -- offers the benefits of both a partnership and a corporation.
Members Have Self-Employment Income
In most states, LLC members are not permitted to be employees, and must receive their share of the profits as personal self-employment income. While this treatment is not typically a choice, most LLC members benefit as personal tax rates are usually lower than corporate tax levels. Were you in a partnership, you'd receive the same tax treatment without the limited liability protection offered by the LLC. While you may not have the choice to have LLC income treated as self-employment income, you may enjoy the typical lower tax rates. Choosing corporate taxation means that LLC members who work for the company can become employees -- if they truly perform verifiable work -- and receive compensation. LLC members who are just investors, however, cannot enjoy employee status and must receive income as dividends.