Self Employment Tax LLC vs S Corp: Everything You Need to Know
With self employment tax LLC vs S corp, both entities offer tax advantages, and you can combine the two. 4 min read
Self Employment Tax LLC vs S Corp
With self employment tax LLC vs S corp, both entities offer tax advantages, and you can combine the two. Many business owners choose the LLC structure instead of using an S corp because LLCs offer greater flexibility and require less formalities. With that, combining an S corp with an LLC has its advantages, depending on your business goals.
If a business owner participates in the business, the owner must pay self employment taxes. As of 2013, self employment taxes apply to the first $113,700 of wages, net earnings, and tips. Such earnings are also called earned income. When it comes to an S corp, they must pay self employment taxes on services provided to the S corp. They do not pay taxes on profit distributions.
For LLCs, they are taxed in several ways. Sole-owner LLCs are taxed as a sole proprietorships, while multi-member LLCs are taxed as partnerships. Regardless, both LLCs must pay self employment taxes on the first $13,700 of income received. LLCs do not pay business income taxes. Instead, the owners would note the profits they receive on their individual tax returns.
LLCs can choose to be taxed as an S corp. An S corp itself is not a legal entity, but a tax designation from the IRS. This means that an LLC would fall under an S-corp tax classification instead of a sole proprietorship or partnership form of taxation. S corps have advantages, but they do come with more restrictions. If you are thinking of an S-corp tax classification, take note of the following parameters:
- S corps cannot have over 100 shareholders
- S-corp shareholders must be legal residents or U.S. citizens
- Other entities cannot own an S corp, such as C corps, LLCs, and partnerships
- S corps can only have one stock type (no tiered stock allowed)
To get an S-corp election, you must submit Form 2553 to the IRS, including Form 8832 in certain cases. For self employed people, they can choose an S-corp tax classification to avoid paying higher Medicare and Social Security taxes. Self employed people usually pay high Social Security and Medicare taxes (also called self employment taxes). With that, you should know that the IRS could take a closer look at your S corp since you’ll be paying lower self employment taxes overall.
Whether you’re an employee or self employed, you have to pay self employment taxes. When working for another individual, you only need to pay a part of the taxes, while your employer would pay the remaining tax owed. However, the self employed must pay all taxes. An employer-employee tax combination usually amounts to around 15.3 percent.
For S-corp distributions, you may label a part of your income in the form of a salary and the other as a distribution. You must pay self employment taxes on the salary end of the income, but you’ll only pay regular taxes on the taxed distribution portion of the income. Overall, you can reduce your self employment tax balance drastically by dividing up your income in the right way.
The IRS tends to examine S-corp classification more closely due to the potential for abuse. For instance, if you make $300,000 in a single year, but only declare $20,000 as salary, you may get a response from the IRS because you’re trying to reduce a large portion of your self employment tax balance. To remedy this, you must give yourself a reasonable salary that’s not artificially low. What’s considered reasonable is up for debate, but the salary should match a typical salary range within your job position.
An S corp may save you on self employment taxes in the short-term, but it could cost you in the long-run. As is the case with other corporations, an S corp comes with ongoing legal and accounting costs. Also, certain states compel you to pay added fees and taxes. For instance, an S corp in California must pay 1.5 percent on income with an annual $800 minimum tax balance. However, such a tax does not apply to sole proprietorships.
Is an LLC Right for You?
For many small businesses, LLCs offer more flexibility, especially if your business endeavors pertain to real estate. This is because corporations are subject to double taxation, one tax at the business level another when shareholders note their LLC earnings on their personal tax returns. On the other hand, LLCs do not pay business income taxes, and LLC members only pay taxes based on his or her share in the LLC.
If you have more questions on self employment tax LLC vs S corp, submit your legal inquiry to our UpCounsel marketplace. UpCounsel’s will help you determine if an S-corp tax election would be the right move for your business. Also, they will provide more information on the benefits and drawbacks on registering for a corporate legal entity.