LLC Owners and Payroll Taxes

Limited liability companies often make their llc owners subject to payroll taxes.

In many cases, in fact, llc owners pay as much in payroll and self-employment taxes as they pay in income taxes. Payroll taxes run roughly 15.3% on the first $100,000 of earned income and roughly 2.9% thereafter!

Fortunately, the limited liability partner self employment tax treatment is usually pretty straightforward as long as you know how an LLC is treated for income tax accounting purposes. Here are the basic rules:

Single-member llcs treated as disregarded entities:

If a single-member llc (or one-owner llc) engages in an active trade or business, the llc pays self-employment tax on its profit. Note that in this case, the single-member llc reports in business income on a Schedule C tax form and calculates its self-employment tax on a Schedule SE tax form.

If a single-member llc doesn't engage in an active trade or business--say, the llc engages in a passive activity such as real estate investing--the llc doesn't pay self-employment tax on its profit. Note that in this case, the single member llc reports its passive income on a Schedule E.

Multiple-member llcs treated as partnerships:

If a multiple-member llc (or multiple-owner llc) engages in an active trade or business, the llc owners, or partners, pay self-employment tax on their shares of the profit. Note that in this case, the multiple-member llc reports its business income on a separate 1065 partnership tax return and the individual partners calculate their self-employment tax bills on their shares of the partnership profit on Schedule SE tax forms which accompany their 1040 individual tax returns.

If a multiple-member llc doesn't engage in an active trade or business, however, then the llc owners don't pay self-employment tax on their shares of the profit. And in this case, the llc owners report their shares of the partnership's profit on their respective Schedule Es.

LLCs treated as C corporations:

If an llc makes an election to be treated as a regular C corporation, the LLC's profits are not subject to self-employment tax. The profits are, however, subject to corporate income tax as reported on the LLC's 1120 corporate tax return. Furthermore, if the corporate profits are distributed to llc owners in the form of dividends, the dividends are taxed again at the 15% qualifying dividend rate.

Note that a LLC treated as a C corporation would pay payroll taxes (which are equivalent to self-employment taxes) on any wages paid to llc members working in the business.

LLCs treated as S corporations:

If an llc makes an election to be treated as an S corporation, the LLC's profits are subject neither to self-employment taxes nor to corporate income tax. The S corporation does need to file an 1120S tax return, however, and through this tax return the LLC's owners get taxed on their respective shares of the corporation's profit.

Note that if an llc owner works in the business, the LLC-treated-as-an-S corporation must pay a reasonable wage to the llc owner. The LLC absolutely does owe payroll taxes on these wages.

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