Only limited liability companies that operate an active trade or business and which are treated as sole proprietorships or partnerships for tax accounting purposes get subjected to self-employment tax.
In comparison, a limited liability company that is holding passive investments (like real estate) and which is treated as a disregarded entity or as a partnership doesn’t subject the LLC members to self-employment taxes.
Furthermore, note that a limited liability company that has elected to be treated for tax accounting purposes as an S corporation or a C corporation doesn’t subject the LLC members (owners) to self-employment tax. An S corporation or C corporation will owe equivalent Social Security and Medicare taxes on wages paid to shareholder-employees, however.
Self-employment taxes owed by a “sole proprietorship” LLC or a “partnership” LLC can be substantial.
As a rough approximation, in the case of a single-member limited liability company operating for tax purposes as a sole proprietorship, self-employment tax hits roughly the first $115,000 of business profit with a 15.3% Social Security tax, hits income between $115,000 and $200,000 ($250,000 if married) with a 2.9% Medicare tax, and then hits any income above $200,000 (or above $250,000 if married) with a 3.8% Medicare surtax.
If the “sole proprietorship” LLC makes $200,000 in profit, for example, the proprietor pays about $20,000 in self-employment taxes (an amount that’s in addition to the income taxes the proprietor pays.)
In the case of a two member limited liability company operating an active trade or business where the business makes $300,000 in profit ($150,000 per partner), each partner pays the 15.3% self-employment tax on the first $115,000 of profit and then 2.9% on any excess over and above the $115,000.
In this case, the total self-employment taxes paid on the partnership profits roughly equals $36,000, or about $18,000 per LLC member.
A handful of additional comments can be made concerning limited liability companies and self-employment taxes:
- One half of the self-employment taxes paid may be taken as a tax deduction when calculating one’s self-employment tax and income taxes.
- Self-employment taxes are not paid by the LLC or calculated on the LLC tax return. Self-employment taxes get calculated and shown on the Schedule SE form that goes inside the LLC member’s individual tax return.
- The amount of self-employment earnings subject to the 15.3% tax rate is annually adjusted for inflation. (In 2013, for example, the precise amount subject to the 15.3% tax is $113,600. But I’m guessing in 2014, the 15.3% tax will apply to about the first $117,000. In this page’s discussion, I’m using $115,000 just for rough-guess purposes.)
- Commonly, an LLC elects to be treated an S corporation in order to reduce the employment taxes directly or indirectly paid by working members. Note that the premium versions of the limited liability company kits sold here explain when and how to make this election.