Do LLC Owners Pay Self-Employment Tax?
Learn how self-employment tax applies to LLC owners, the impact of tax classification choices, and strategies for managing tax obligations effectively.
LLCs offer flexibility in taxation and structure, making them a popular choice for small business owners. A common question is whether LLC owners must pay self-employment tax on their earnings. Since tax obligations depend on an LLC’s structure, understanding when these taxes apply helps business owners plan effectively.
Income Treatment of a Single-Member LLC
A single-member LLC (SMLLC) is treated as a disregarded entity for federal tax purposes by default. The IRS does not recognize it as separate from its owner, so all income, deductions, and credits flow directly to the individual’s personal tax return. Business earnings are reported on Schedule C of Form 1040, similar to a sole proprietorship. This simplifies tax filing since there is no separate business tax return unless the owner elects a different tax classification.
Because an SMLLC is a pass-through entity, all revenue—whether from sales, service fees, or other business activities—is considered the owner’s personal income. Business expenses such as rent, supplies, and marketing costs can be deducted to lower taxable income. If the business operates at a loss, that loss can offset other personal income, reducing overall tax liability.
Self-Employment Tax Liability
Self-employed individuals must pay both the employer and employee portions of Social Security and Medicare taxes, totaling 15.3% in 2024. This includes 12.4% for Social Security (on earnings up to $168,600) and 2.9% for Medicare. If net earnings exceed $200,000 for single filers or $250,000 for married couples filing jointly, an additional 0.9% Medicare surtax applies.
LLC owners do not receive a W-2 or have payroll taxes withheld. Instead, they calculate and pay self-employment tax when filing their annual return using Schedule SE. Unlike traditional employees who split payroll taxes with their employer, LLC owners cover the full amount but can deduct half of it when calculating adjusted gross income.
Quarterly estimated tax payments are required if total tax liability exceeds $1,000 for the year. These payments, made using Form 1040-ES, help avoid penalties. Accurate record-keeping of income and deductions is essential to prevent underpayment issues.
Electing Corporate Tax Status
LLC owners can choose to be taxed as an S corporation or C corporation, which affects how profits are distributed and taxes are paid. By default, an LLC’s earnings pass through to the owner, meaning all profits are subject to self-employment tax. Electing corporate taxation allows the owner to take a salary while the remaining profits are taxed differently.
An S corporation election, made by filing Form 2553 with the IRS, allows owners to classify themselves as employees. They receive a salary subject to payroll taxes, but additional profit distributions are not. This can reduce self-employment tax liability, though the IRS requires wages to be reasonable based on industry standards. S corporations must also comply with payroll tax reporting requirements, including quarterly filings on Form 941 and year-end reporting on Form W-2.
A C corporation election, made using Form 8832, results in the business being taxed separately from its owners. The corporation pays a flat 21% tax on its income, and any dividends distributed to shareholders are taxed again at the individual level. While this creates the possibility of double taxation, it allows profits to be reinvested at the corporate tax rate, potentially lowering the owner’s personal tax burden. C corporations can also offer benefits such as health insurance and retirement contributions that are deductible to the business without being subject to self-employment tax.
Multi-Member LLC Distinctions
When an LLC has more than one owner, the IRS classifies it as a partnership for tax purposes unless an election is made for corporate treatment. Profits, losses, and deductions are allocated among members based on the operating agreement. Unlike a single-member LLC, which reports income on Schedule C, a multi-member LLC must file Form 1065, U.S. Return of Partnership Income. Each member receives a Schedule K-1, detailing their share of earnings and deductions for their individual tax returns.
Income distribution affects tax liability. While profits are typically divided according to ownership percentages, an LLC can establish special allocations if properly documented. For example, if one member contributes more capital while another manages daily operations, the operating agreement can specify a different profit-sharing arrangement. However, the IRS requires these allocations to reflect actual financial contributions or risks undertaken by each member. Allocations designed solely to minimize taxes may not hold up under audit.