Should You Pay Self-Employment Tax as an LLC Partner
Can you consider yourself as a sole proprietor even though your company is registered as a limited liability company? Should you therefore be paying self-employment tax? When do you pay and not pay self-employment tax as an LLC partner?
Our guide could help you understand the basics of self-employment tax for LLC members.
In general, self-employment taxes are paid by sole proprietors or independent contractors such as dentists, lawyers and auctioneers who offer services to the public. Members of limited liability companies pay or do not pay self-employment taxes depending on certain conditions.
For example, some business owners are sole members of a domestic liability company. But according to the IRS, they are not considered sole proprietors if they opt for corporation-treatment for the LLC. Form 8832 of the IRS explains this further in www.irs.gov.
When Does an LLC Partner Pay Self-Employment Tax?
Generally, an LLC partner is subject to self-employment taxes for income derived from his performance of a trade for the company, such as consulting or accounting. This LLC partner is described as a general partner. Limited partners of an LLC, on the other hand, are not subjected to self-employment tax in the sense that they derive income from capital investment and not from services performed. Currently, the ultimate reference for answers to questions on whether an LLC partner should pay self-employment tax is the IRS’ Proposed Treasury Regulations section 1.1402(a)-2(h)(2). Under it self-employment taxes are required for LLC partners who are authorized to enter into contract on behalf of the partnership, and have rendered more than 500 hours of service for the company during the tax year.
Incorporating as an S corporation or an LLC
The ambiguity regarding self-employment taxes for LLC members can make deciding whether to incorporate as an S corporation or an LLC a difficult task. Incorporating as an S Corporation is sometimes attractive to avoid the 15.3% self-employment tax. Under an S Corporation, profits are not subject to self-employment tax; they are "passed through" to the shareholders' individual income tax. Only salaries -- which should be a reasonable amount by industry standards -- are subject to the self-employment tax under an S corporation. On the other hand there are certain deductions allowable under an LLC that could effectively be beneficial for a partner. For example, half of the self-employment taxes can be deducted from personal income tax return.
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