If you’re a member of a limited liability company (LLC), do you have to pay self-employment taxes? That’s a darn good question.
Our beloved Internal Revenue Code’s self-employment (SE) tax provisions were enacted long before the existence of limited liability companies. As LLCs became increasingly popular, an important question arose: how to apply the SE tax rules to individuals who are LLC members, which is what LLC owners are called. Despite IRS attempts to make it go away, that question still exists for LLCs with several members, which we will call multi-member LLCs. Here’s the muddled SE tax story for LLC members.
Individual members of ‘disregarded’ single-member LLCs (SMLLCs) are on the hook for the SE tax
Before addressing the SE tax issue for members of multi-member LLCs, let’s quickly dispose of the issue for single-member LLCs (SMLLCs), meaning those with only one owner. The existence of a single-member LLC (SMLLC) is generally disregarded for federal income tax purposes unless you make an election to treat it as a corporation — which is not done very often. In other words, a so-called disregarded SMLLC owned by you as an individual is invisible for most federal income tax purposes, including SE tax purposes.
Therefore, when you own a disregarded SMLLC that’s engaged in a business, you must calculate your SE tax hit on Schedule SE, just like a sole proprietor does. So, you will owe SE tax on any net SE income produced by the SMLLC. No question about it.
The muddled SE tax issue for members of multi-member LLCs
Now it gets interesting. We start with the fact that members of LLCs that are classified as partnerships for federal income tax purposes are treated as partners for federal income tax purposes. So, as a general rule, the same federal income tax rules, including the SE tax rules, that apply to individual partners also apply to individual LLC members who are treated as partners.
Moving right along, to understand the SE tax issue for LLC members, we must start with the longstanding special SE tax rule for limited partners. Under that special rule, a limited partner includes in SE income only guaranteed payments from the partnership for services rendered to the partnership. Guaranteed payments are payments that are determined without regard to the partnership’s income. They are often called “partner salaries.” This special SE tax rule for limited partners is beneficial to them because they typically do not receive any guaranteed payments for services (partner salaries), and therefore they typically do not owe any SE tax on their shares of partnership income. Source: Internal Revenue Code Section 1402(a)(13).
In contrast, a general partner must include his or her share of the partnership’s net income from business activities in SE income. Therefore, general partners usually owe SE tax on their shares of net partnership income. Source: Internal Revenue Code Section…
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