The numerous small business taxes can be a killer, and in large part that’s because a lot of business owners don’t know how to avoid self-employment taxes.
In this blog, I’ll talk about how LLCs taxed as partnerships can elect to be taxed as S-corporations, and why it’s a great option for owners of growth-stage businesses looking to ease the burden of self-employment taxes.
But first, I’ll need to explain a few things, like how self-employment taxes work for LLCs that are taxed as partnerships.
A short primer on self-employment taxes and partnerships
Self-employment taxes are divided into two components: Social Security and Medicare.
Here’s what you pay when your LLC is taxed as a partnership
If you earn income through self-employment, as multi-member LLCs (taxed as partnerships) do, these taxes add up to 15.3% of your net earnings — 12.4% for Social Security and 2.9% for Medicare.
And here’s why self-employment taxes apply to partnerships
An LLC is, by default, taxed as a partnership. Partnerships are pass-through entities that pass business income directly to their members—the owners, for all intents and purposes.
Business income becomes personal income, and that personal income is subject to self-employment taxes.
But what if the owners of an LLC were classified as employees? That brings us to S-corps.
How LLCs taxed as S-corps avoid self-employment taxes
The IRS defines an S-corp as “corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.”¹
S-corps owners are taxed as employees, not owners
With an S-corp, the business owners are considered employees. That means they only pay Social Security and Medicare taxes on the wages and salaries they get from the business. Individuals pay half of that 15.3% tax. Your business pays the other half.
Here’s how S-corps save you money
After you, as a shareholder, are set up as an employee and paid a reasonable wage, any profits distributed to you aren’t subject to Social Security and Medicare taxes (but you still have to pay income tax on those profits).
You need a tax professional to make the transition
I’m a Fort Worth-based CPA with more than a decade of experience helping businesses like yours reduce their tax liability. I can help you set up your LLC to be taxed as an S-Corp. It’s too complex to manage on your own. Let’s do it right, and we’ll get you real savings.
Schedule a discovery call with us today.
Jeremy A. Johnson, CPA