Self-employment tax is owed on income generated by owners of a business. Under the Internal Revenue Code, owners of sole proprietorships and limited liability companies under the default LLC tax rules pay self employment taxes resulting from the income generated by the business.
There is a maximum amount of income for this tax so when income reaches a certain point, then self-employment taxes will not longer be owed on the excess income. So, if your business intentions are to make more than $120,000 or so a year, it may not be worth planning for self-employment taxes and just focusing on making more revenue. Overall, the single layer of income taxation is worth paying the self employment taxes for the initial stage of income.
The above rules apply to an LLC which is being taxed pursuant to its default tax structure which is a pass through structure. However, after forming an LLC for a business, the limited liability company has the option of electing to be taxed as an S corporation or a C corporation.
Under an S corporation tax structure, business owners can be employed by the LLC and only the salary paid to the owner will be subject to employment taxes. Excess profits distributions are not subject to self-employment taxes. Now, the IRS does require that a reasonable salary be paid and they are quite strict about ensuring that this rule is not abused by business owners. For example, if you are the sole owner of an LLC and provide consulting services which are paid by the hour, it will be hard to justify that your salary should be significantly less than the income generated by your services directly.
On the other hand, if your LLC business is selli g a product and you have assets of value and/or other contractors and employees, then your salary will not be based on the actual revenue generated.
Accordingly, it is important that you seek the advice of your accountant or tax attorney to ensure that based on your business activity and situation, this kind of structure may be acceptable for reducing overall self employment taxes generated by your LLC business.
Similarly, with a C corporation tax structures, employment taxes are only paid with respect to salaries paid out to owners of a business (this applies to any employees of the business). However, an LLC business taxed under the C corporation tax structure is subject to double taxation when it comes to income taxation so there is a possibility that any employment taxes saved may be spent on income taxes. Again, check with your accountant or lawyer to determine what tax structure is best for your particular situation.
