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Self-employment taxes and a
LLC
Dear Small Biz Adviser:
I have a small, limited liability company and need to gain an understanding
of self-employment taxes to the partners. I run the operation day-to-day,
while my partner does not work in the business; he is merely a silent
partner. I feel that I must pay self-employment on the income allocated
to me, but my partner should not because he provides no services
to the LLC. I get guaranteed payments, which I know are subject
to self-employment taxes. Could you help us sort out this matter?
Joe
Dear Joe:
The LLC is a relatively new phenomenon of legal business structures
that took root in the early 1990s. It has become a popular choice
for companies, but many issues surrounding the LLC structure remain
relatively unchallenged in the court system.
Further complicating any discussion of this type of
business is the fact that conditions vary from state to state regarding
LLC taxation and legal requirements. For example, in some states,
a single individual can form an LLC; in others, at least two persons
are required.
There also is the matter of the titles and responsibilities
held by each of you in the LLC. There is a clear distinction between
membership and management roles in the company. A member stakes
ownership. A manager may or may not have ownership status. In your
case, it appears both are members, while you are the manager.
Therefore, I cautiously assume your partner is a member
and takes part in the distribution of profits in the form of dividends.
It appears that you, as manager, are receiving some form of wage
or salary compensation. You may or may not partake in the dividend
distribution. That would depend on the nature of the ownership agreement,
articles of merger or plan of merger (if you were two separate entities
prior to forming the LLC), articles of LLC organization, and any
other document that may address forms of compensation between the
two of you.
Wage vs. contract compensation
If you are receiving compensation in the form of a wage or salary,
then the LLC is responsible for paying an equal share of the Social
Security and Medicare contributions. In that case, the withholding
and distributions to the federal government should be occurring
on a monthly basis.
If, on the other hand, you are not listed as an employee,
then it appears the LLC is making contractual payments to you as
the managing partner. Under that circumstance, you individually
are then obligated to make all 15.3 percent of the Social Security
and Medicare contribution. Normally, you should be conducting those
distributions on a quarterly basis.
Internal Revenue Service Form
941 is used to make those quarterly payments. They can be made
more frequently, but you should adhere to a maximum of every three
months.
Your partner, if being compensated only in the form
of dividend distribution, would then submit those earnings with
his personal income tax return. Dividends are not subject to Social
Security and Medicare deductions.
Finally, there is the matter of filing corporate income
tax returns for the LLC corporation. Form
1120 and Form
1120S are used for C and S corporations, respectively.
Ultimately, you need to consult a lawyer or a tax
accountant to best determine self-employment tax obligations. The
distinctions among state LLC requirements, the nature of the management
and membership status of you and your partner, forms of compensation,
any possible contingency associated with merger activity related
to the forming of the LLC, and any other condition not known to
me can impact this matter.
I hope this gives you some focus and direction on
how to proceed. I wish you well.
-- Posted: March 12, 2002
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