Date: August 12, 2022
When do members and LLC Partners pay self-employment taxes?
The most popular business structure seen today is a Limited Liability Company (LLC). It is estimated that over 21 million businesses are LLCs in the US. One of the biggest advantages of this entity type is that it limits your liability as a business owner. This makes it a popular choice. Since it is an entity created by state laws, for tax purposes, the IRS will treat an LLC as one of the following: a corporation, partnership, or as a ‘disregarded entity’ (which is a single member LLC). So, this brings us to the golden question: Does a member of an LLC or a partner have to pay self-employment taxes on their share of the entity’s income?
Spoiler alert – the answer is very complicated, which we have come to expect from the IRS. Federal law doesn’t recognize a single member LLC as a legal entity, which means it is always taxed as something else (sole proprietorship, partnership, or corporation).
How does the IRS determine how to tax an LLC? You would think with it being the most popular business structure, they would have a definitive answer, but that is not the case! This is perfect example of why we are so dedicated to making sure small business owners are set up in an optimal entity structure, so that they pay the least amount of tax possible, so they can navigate the over complicated tax codes more effectively.
A single member LLC is treated by the IRS Tax Code as a sole proprietorship (unless the owner elects’ taxation as a corporation, which rarely happens). This means that the single member LLC files a Schedule C on their personal tax return and pay self-employment tax on the net profit. Now, multiple member LLCs are treated as partnerships for tax purposes (again, unless they elect taxation as a corporation). A partnership is a business arrangement like a sole proprietorship but with two or more partners. You can be a general partner, meaning you are an owner, or you can be a limited partner, which is basically a silent (passive) partner.
The proposed IRS regulations stipulate that ALL members of member managed LLCs can’t be treated as limited partners and therefore each must pay self-employment tax. Members could qualify as limited partners if they work no more that 500 hours per year in the LLC business.
The tax code can give you a massive headache. Finding solutions is what we do, using transparent, legal strategies to reduce or even eliminate your tax bill. Our tax strategists help make sure that you are utilizing all the strategies available to reduce or eliminate your tax obligation (LEGALLY)! If this is something you feel is worth exploring, contact one of our tax strategists here for a no-strings-attached assessment.