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Self Employment Taxation in an LLC

written by: Mridula B•edited by: Ronda Bowen•updated: 1/31/2010

An LLC is taxed as a sole proprietorship or partnership. Owner or members pay the self employment tax. Alternatively, LLCs can opt to file tax as corporations through Form 8832. This article aims to discuss the LLC Self Employment Tax.

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    Understanding LLC

    LLC or Limited Liability Company is a different from a corporation or partnership. LLC owners are not shareholders, they are "members."

    LLC includes some aspects of both partnerships and corporations. LLC offers much more flexible than a typical corporation. It offers protection as well as certain advantages similar to a corporation. For example: Members are not held personally liable for company debts. Assets of members cannot be seized as they are different from LLC.

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    Understanding Self Employment Taxation for LLC

    The owner’s income from the LLC is considered to be self employment income. If the owner’s net income from LLC exceeds $400, he or she is liable to pay self-employment tax. He or she has to file this tax on his or her personal income tax return (Form 1040).

    LLC Self Employment Tax - The LLC "self-employment tax" rate is 15.3% (12.4% for social security + 2.9% for Medicare (hospital insurance).

    Only the first $106,800 of your combined wages, tips, and net earnings in a tax year is subject to 15.3% of self employment tax.

    A LLC member performing functions in areas other than Engineering, Health, Law, Consulting, Actuarial Science, Accounting or Architecture is only be liable to pay self employment tax if he or she takes part in trade or business for more than 500 hours in a tax year.

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    LLC Self Employment Tax Benefits

    LLCs offer several tax benefits when it comes to self-employment taxes:

    • As an LLC owner, you can subtract half of the self-employment taxes you pay on your personal income tax return, Form 1040. This will lower the overall effective taxes and shifts the advantage to the LLC.
    • LLC owner may evade the self-employment tax when LLC pays to the owner lease payments and loan repayments.
    • An LLC doesn’t pay federal and state unemployment taxes on the owner's income together with guaranteed payments received for salary.
    • Internal Revenue Code inflicts the self-employment tax on earnings from ownership of the business, and any guaranteed payments for salary. The owner is not considered "in the business" of leasing real estate (or equipment, furniture, etc) or making loans and, the tax does not apply to these receipts. (Moreover, the Code also particularly exempts lease earnings received from anyone except a real estate dealer).
    • Loan repayments and lease payments are made to the LLC owner for a reason besides his or her capacity as owner. Accordingly, they are subtracted by the LLC while calculating its distributable income. As the LLC does not pay taxes itself, this could be a way to give out income to a particular owner, avoiding the self-employment tax.
    • "Guaranteed payments" paid to LLC owner, salaries (for services provided) are also deductible by the LLC. But they are subject to the self-employment tax for the member who receives the payments. They are added to his or her share of the LLC profits, and he or she must pay the self-employment tax on the total.

    The LLC Self Employment Tax remains ambiguous for many despite its growing popularity. I hope this article clears out the doubts for you.