LLC vs. S corporation
Are LLCs treated as S corporations or partnerships from a self-employment
tax perspective? Is income from a general partnership liable for
self-employment tax? How are LLCs treated? Do we have to pay self-employment
tax on income derived from an LLC? Thank you.
A limited liability company, or LLC, with two or more members is
treated as a partnership unless it elects to be treated differently.
The trade or business income of a partnership is considered self-employment
income to the managing members similarly, as in the case of a partnership's
general partners. Rental income is not considered self-employment
income to any member. This difference in treatment is generally
why an LLC is used in real estate operations, whereas an S corporation
is used for business operations.
Now, I know some people are going to say that you
can't avoid Federal Insurance Contributions Act, or FICA,
taxes by using an S corporation over an LLC. That's not true. The
net income of the LLC is usually considered the self-employment
income, which is subject to 15.3 percent tax. A company's net income
does not truly reflect its ability to pay salary so that the partners
end up paying self-employment tax on funds that are not available
for distribution. In an S corp, there is no self-employment tax.
Instead employment taxes, which are basically the same rate as self-employment
tax, are due on declared salary. If these funds are tied up in assets,
they're not available to declare as salary and, hence, employment
taxes will be less.
For example, if a company accumulates assets through
its income stream, the funds are tied up and not available to be
paid to the partners. But in an LLC, the partners (members) do end
up paying self-employment tax on assets, such as inventory and accounts
receivable. This would not be the case by using an S corp. In addition,
items such as health insurance, luxury auto limits, one-half of
entertainment and other nondeductible items contribute to a partner's
self-employment income, but not to S corp shareholders.
In summary, if it's not rental real estate, use an S corp.
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