Method 1: Create an LLC with a Modest Guaranteed Payment
As an initial step of SE tax saving, convert the existing husband–wife partnership to husband–wife LLC by registering with the respective state authority (the Secretary of State). As far as the Federal Income Tax is concerned, both partnership and LLC are treated in the same manner. In the case of husband–wife LLC, it protects the personal assets of both the partners from business-related liabilities. Both the husband and wife are classified as Limited Partners for SE tax purposes. The Limited Partners are eligible for guaranteed payments. Guaranteed payment is a fixed amount paid monthly or quarterly, and this amount does not depend on the income from business. The SE tax is calculated only on the guaranteed payment. In Schedule K-1 and joint form 1040, only the guaranteed payments are entered as SE income. The remaining income of husband–wife LLC can be withdrawn as cash when it is available.
Let us see how this SE tax saving plan works by using the above mentioned example. According to $ 300,000 SE income on partnership business in 2009, each partner has to pay $ 17,593.2, and hence, the total SE tax becomes $ 35,186.4. Assume that a guaranteed payment program is implemented from 1 January 2009 on the husband–wife LLC by making a payment of $ 5,000 per month. In such case, each of them has to collect $60,000 as guaranteed payment. Further, each partner has to pay only $ 9,180 SE tax, and therefore, the combined total becomes $18,360. This tax saving plan reduces the SE tax by $16,826.4.