Self Employment Tax and S Corp Status

I have a few questions.

It is to my understanding that a LLC owner must pay self employment tax. If I file a form with the IRS to treat me as a S-corp, will this avoid the SE tax?

In order to treat my LLC as a S-Corp, do I need to file form 2553? or must I file both Form 8832 and 2553?

Also if I am elected as S-corp (but still organized under a LLC) can I still have disproportional distributions of income among the member-owners?

Answer

As an S-Corp, it is true that you do not have to pay self employment tax on dividends paid to the owners.

However, the IRS knows about this loophole and requires S-Corporation owners to pay themselves a “reasonable” salary–which IS subject to self-employment tax.

So you can’t entirely avoid self-employment tax with an S-corp, you could possibly reduce it if your LLC’s profits exceed what is a “reasonable” salary (as determined by the IRS) and you can therefore take some of your profits as a non-self-employment tax dividend.

In addition, Obamacare has enacted a 3.8% Medicare tax on dividends, so even S corps that distribute income as dividends do not avoid all self employer taxes.

File the 2553 timely and you do not have to file an 8832 (see the bottom left to top middle of page 4 of Form 8832).

You CANNOT make unequal distributions to S-corporation shareholders.

One of the qualifications for an S-corporation is that it has only one class of stock. If you make unequal (meaning, disproportionate–e.g. if someone owns 10% of the stock they get something other than 10% of the profits) distributions, you have created multiple classes of stock and now you are a double-taxed corporation.

To keep your S-corporation status, you must distribute the same number of dollars per share to every shareholder, otherwise you lose it.

This is part of the reason why many multi-member LLCs choose to be taxed as partnerships, rather than S-corporations, despite the ability to partially shelter some S-corporation profit (but not all) from self-employment tax.

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