Owners of an LLC choose to reduce their individual self-employment tax burden by electing to have the LLC treated as a corporation for tax purposes. Most LLCs elect classification as an S corporation (under Subchapter S of the Internal Revenue Code) when they want to minimize their owners' self-employment taxes.
Self-employment offers many freedoms and opportunities. But you may be surprised to find that your tax bill will be much higher when you are self-employed. Self-employed people have to pay self-employment taxes, which can be a shock to your budget.
You may be able to reduce the amount of tax you pay by setting up a limited liability company (LLC) or a limited company.
You can deduct (write off) legitimate business expenses from your business income, which can greatly reduce the profits you have to report to the IRS.
Deductible expenses include start-up costs, car and travel expenses, equipment costs and advertising and promotion costs.
Sole proprietors, partners in a general partnership, and members of a limited liability company that is taxed as a disregarded entity must pay self-employment tax.
Many businesses make quarterly estimated payments to the IRS to avoid being surprised with a large annual bill and costly fines or penalties.
You can estimate your taxes with an online tax calculator.
Self-employment taxes are not paid on passive earnings or income from any investments you have made. If you own a small business, not all of your money is earned as a result of work on your behalf.
Some of your income may come from the value of your business, such as the good reputation you and your business have built up in the areas in which you operate or the profitability of your employees.
The problem for sole proprietors and sole proprietorships is that all of your income is reported on a Form C. Therefore, every penny you earn is considered earned income and is subject to self-employment tax. Paying extra tax for being your own boss is no fun.
The good news is that self-employment tax will cost you less than you might think, because you can deduct half of the self-employment tax from your net income when calculating your income tax.
The Internal Revenue Service (IRS) treats the self-employment portion of the tax as a business expense and allows you to deduct it accordingly. There are several types of LLC taxes. The federal government, as well as state and local governments, collect these taxes.
All LLC members are responsible for paying income tax on any income they earn from the LLC, as well as self-employment taxes.
Depending on what you sell and whether you employ anyone, you may also be responsible for paying payroll taxes and sales taxes.
To complicate matters further, an LLC may choose to be taxed as a separate business entity. A significant number of taxpayers have argued that none of the residual profits after deducting guaranteed payments, or so-called distributive profits, are subject to self-employment tax, even if those profits were allocated to a managing or otherwise actively working member.
To be fair, some taxpayers have taken a more conservative view by applying the proposed regulations and limited case law to subject some or all of their distributive share to self-employment tax.
However, taxpayers today use both methods with little consistency. Limited partners (limited both in their ability to manage the partnership and in their liability for the partnership's debts) can exclude their distributive share for personal income tax purposes.
General partners (fully active in the management of the partnership and unlimited in their liability) are subject to income tax on their distributive share.
However, with the development of LLCs, federal tax law now clashes with state entity statutes. A member of an LLC can enjoy limited liability and yet actively participate in the management of the LLC.
Talk to your CPA or tax professional about the potential benefits of electing corporation status for your LLC.
As an owner of a single-member limited liability company (SMLLC) (with the default tax classification of disregarded entity), you are not considered an employee and the income you receive from your business is not considered wages.
The information on Schedule E is ultimately carried over to your Form 1040 and is taken into account in your overall income tax liability.
The IRS has indicated that it intends to litigate reported exclusions from self-employment taxes on earnings distributed to LLC members who are in a position of management control or who provide significant services to an LLC.
For owners of sole proprietorships, partnerships, limited partnerships and certain trusts, estates and limited liability companies (LLCs), this deduction is a great advantage.
In addition to the office space itself, expenses you can deduct for your home office include the business percentage of deductible mortgage interest, home depreciation, utilities, homeowner's insurance, and repairs you pay for during the year.
Consultants and freelancers are often surprised at how much income they can deduct from self-employment taxes. The IRS uses a payroll tax payment system, so you will need to deposit your payroll taxes throughout the year according to the schedule set by the IRS.
And if you are unsure, seek professional help with your business tax return from a certified public accountant (CPA) or other accredited tax preparer.
Every owner who is subject to self-employment tax reports the amount due on Schedule SE, which must be filed annually with your tax return.
LLC members are considered self-employed business owners and not employees of the LLC, so they are not subject to withholding tax. The tax you pay as a self-employed person is called self-employment tax, and you may be able to reduce the amount by forming a limited liability company or a corporation.
