Multi-Member LLCs and Self-Employment Tax
By: Marian Pekelder
If you have a multi-member LLC and no one is paying self-employment taxes, you may be inadvertently putting yourself in an unsafe tax situation.
There are proposed regulations that govern when a member of an LLC should be subject to Self Employment tax (S-E tax). This proposed regulations state that an LLC member will be treated as a limited partner and not subject to S-E income unless the LLC member either:
- Has personal liability for the debts of the LLC under state law.
- Has authority under state law to contract on behalf of the LLC, or
- Participated in the trade or business of the LLC for more than 500 hours.
Essentially, whoever is running the LLC should be subject to S-E tax.
What is S-E Tax?
S-E tax is payroll taxes for a person who does not work for an employer. When a person has an employer, typically, the employer pays half the payroll tax and the employee pays half. When you are in an S-E tax situation, the total payroll taxes and all is paid by the responsible person.
The interesting thing about this is that a single member of an LLC files as a sole proprietorship and is always subject to S-E tax. The sole proprietor pays all the payroll tax which comes to approximately 15.3% of the income earned.
A multi-member LLC is required to operate as a partnership and follow partnership rules, if an election to be treated as an S-corporation is not made. In the case of a new business with uncertain income, or a business that will never have much income, I recommend that they not make an S election for the first few years because then, payroll returns are required to be filed to pass some payroll tax to the shareholder.
When are S-E Taxes Applicable?
The confusion about the applicability of S-E tax for a multi-member LLC is most likely because after IRC Section 1402(a)(13) was added to the code and Limited Liability Companies came into existence, ALL of the members of the LLC had limited liability.
Even though the IRS has still not issued permanent regulations, cases regarding this have gone to court. In some of these cases, the LLC members have lost. Why take the chance with having all LLC members coded as limited liability members to keep from paying payroll taxes? If regulations change, the penalty could be expensive. Prior income can be re-classed as self-employment income, subject to not only the payroll taxes, but also penalties and interest.
Here’s the takeaway: Somebody has to be running the business and that person has to pay self-employment tax. If you are unsure of your tax situation, please contact hb&k. We have experts who can answer your questions and make sure you are in a tax-safe situation.