How to Avoid Self Employment Tax with LLC
How to avoid self employment tax with LLC is one way that many self-employed professionals use to reduce or completely avoid self-employment taxes.3 min read
How to avoid self employment tax with LLC is one way that many freelancers and other self-employed professionals use to reduce or completely avoid self-employment taxes that can eat up a large portion of their earned income.
Reducing Self-Employment Taxes With LLC
Being self-employed comes with a number of benefits such as:
- You don't have to worry about going to an office every day.
- You don't have to answer to a boss.
- You don't have to worry about a dress code.
Self-employment has one major drawback, though. You're required to pay self-employment taxes on every penny you earn. Consultants and freelancers often find themselves a bit shocked at how much of their earned income can be taken away by self-employment taxes. One of the most common complaints among people who own a business, in fact, is the self-employment tax. You may be wondering if it's possible to avoid these taxes. The short answer is yes, for the most part, but you'll need to make an effort.
Depending on your specific situation, it may be possible to reduce or completely negate self-employment taxes if you form either a limited liability company or some other form of corporation.
Understanding Self-Employment Taxes
When you're an employee on somebody else's payroll, your employer actually pays half of the Social Security and Medicare taxes on your income. The other half is withheld from your paycheck. When you're self-employed, however, you're required to pay the full amount of these taxes on your own. This is known as the self-employment tax.
In 2014, Social Security taxes were assessed at 12.4 percent of earned income while the Medicare tax was assessed at 2.9 percent. You're only required to pay Social Security taxes on the first $117,000 of your annual income. Any amount over this is not subject to Social Security taxes. Medicare taxes, however, are assessed on any amount you earn, with an additional 9 percent assessed against any amount you make over $200,000 in a calendar year.
You may be subject to self-employment taxes if you are:
- A freelancer or independent contractor
- A sole proprietor
- A member of a general partnership
- A member of an LLC that is considered a disregarded entity for tax purposes
You may be required to calculate your self-employment and income taxes in quarterly estimates that are submitted to the Internal Revenue Service. If you don't, you may be responsible for paying additional penalties or fines. Many people find tools, such as online self-employment calculators helpful when estimating their taxes.
Keep in mind that these self-employment taxes are due on top of any other regular federal income taxes you may owe to the IRS. Self-employment taxes are intended to be paid on what is known as "earned income." Earned income is the amount of money you earn from working or producing a product or service.
Self-employment taxes are not intended to be paid on passive earnings or income from any investments you have made. If you are a small business owner, not all of your money is "earned" as a result of labor on your part. Some of your income may come from the value of your company, such as the good reputation you have built for yourself and your company in the areas in which you operate or the profitability of your employees. The problem for sole proprietors and single-member LLCs is that all their income is reported on a schedule C form. Therefore, every penny they bring in is considered earned income and is subject to self-employment tax.
In simple terms, you'll be paying a total self-employment tax of 15.3 percent on every penny you earn. One simple trick to reduce these taxes it to set things up, so you'll be taxed as an S-corporation. Normally, a business can be registered with its state as an LLC and registered with the IRS as an S-corporation. This provides business owners with the legal protections associated with limited liability companies while allowing them to take advantage of the tax benefits that come with being recognized as an S-corporation.
If you need help with how to avoid self employment tax with LLC, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies such as Google, Menlo Ventures, and Airbnb.