LLC vs Self Employed: Everything You Need to Know
Being treated as an LLC vs. self-employed person can make a world of a difference in the amount of taxes you pay. If you're an employee, the employer will pay 50 percent of your Medicare and Social Security taxes.3 min read
2. Taxes for Corporations and LLCs
3. Avoiding the Self-Employment Tax
4. How To Be Taxed as an S Corporation
5. What Is an LLC?
Updated October 29, 2020:
Being treated as an LLC vs. self-employed person can make a world of a difference in the amount of taxes you pay. If you're an employee, the employer will pay 50 percent of your Medicare and Social Security taxes. If you're self-employed, you have to take care of all your taxes yourself. The tax you pay as self-employed is called the self-employment tax, and you might be able to reduce its amount by forming a limited liability company or a corporation.
Self-Employment Tax Rates
Self-employment tax rates are:
- 12.9 to 15.3 percent for Social Security paid on the portion of your income up to $117,000
- 2.9 percent for Medicare plus an additional 0.9 percent on yearly wages over $200,000
Sole proprietors, partners in a general partnership, and members of an LLC that's taxed as a disregarded entity must pay self-employment taxes. Many businesses make estimated quarterly payments to the IRS to avoid being surprised with a large yearly bill and costly fines or penalties. You can estimate your taxes with an online tax calculator.
Taxes for Corporations and LLCs
Unlike partnerships and individuals, the IRS treats all corporations like C corporations automatically. The corporation pays income tax on earnings, and its owners, also called shareholders, pay some personal income tax on the amounts they receive as well. Many small businesses choose to pay taxes as S corporations instead. An S corporation doesn't pay corporate income tax, and its shareholders report the company's income on their personal returns.
An LLC can be taxed as a disregarded entity, which means that it is taxed as a sole proprietorship or a partnership. It can also be taxed as an S corporation. Partners in a limited partnership or a partnership that's taxed as a corporation are not self-employed. The owners or shareholders of corporations receive income from dividends. Because this income isn't from self-employment, it's not subject to the self-employment tax. Compensation from your corporation is employment income, so employees pay the employee tax rate rather than the self-employment rate.
Avoiding the Self-Employment Tax
If you're a sole proprietor, a partner, or an LLC that's a disregarded entity, you'll pay Medicare and Social Security taxes on your percentage of your company's net income or profits. If your business is an S corporation or an LLC that's considered an S corporation, you'll pay Medicare and Social Security taxes only on the salary you receive, not on your company's other profits. You can't avoid self-employment taxes entirely, but forming a corporation or an LLC could save you thousands of dollars every year.
If you form an LLC, people can only sue you for its assets, while your personal assets stay protected. You can have your LLC taxed as an S Corporation to avoid self-employment taxes. However, you may not need an LLC if you have a good professional liability and property insurance coverage and do not have many assets.
How To Be Taxed as an S Corporation
To form a corporation or an LLC, you must file the correct documents with the secretary of state or another designated agency in the state where your company is located. The IRS automatically taxes all corporations as C corporations that pay corporate income tax. It taxes LLCs as disregarded entities whose owners pay self-employment tax on all their earnings. To be considered an S corporation by the IRS, you must file form 2553. If your company is an LLC, file form 8832.
What Is an LLC?
Owners of an LLC can take advantage of limited liability, like the owners of a corporation. LLCs can also pass through profits to the owners, so they're taxed at the lower individual rate. There are no limits on the number of owners an LLC can have. LLCs can file taxes as sole proprietors, also called single-member LLCs. They can also file taxes as S corporations or partnerships. The costs of creating an LLC depends on the state you want to do business in.
A single-member LLC protects your personal assets from the creditors. Setting up an LLC also lets you avoid paying personal and business taxes on your freelance income. As a pass-through entity, all the income and expenses of an LLC get reported on your personal income tax return.
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