If you’ve received a salary your whole working life, you’ve already been paying Social Security and Medicare taxes…aka self-employment tax.
It’s just that your employer has done the work of calculating, filing, and paying those taxes on your behalf.
Also, your employer paid half of those taxes for you. Of course, your employer set your salary knowing what those taxes would cost it, so you weren’t getting a free lunch as an employee.
As a self-employed business owner, you are the employer and are responsible for calculating and paying your self-employment taxes.
As a small business owner, you’re still required to pay payroll taxes such as FICA (Social Security) and Medicare taxes on your income, only now it’s called Self-Employment tax (SE). Now that you’re self-employed, it’s your job to calculate and report your employment taxes.
How a Single-Member LLC Computes SE (Self-Employment) Tax
As a single-member Limited Liability Company, the IRS treats your LLC for tax purposes as a “disregarded entity”, which is taxed as a sole proprietor for income tax purposes. Don’t worry, all the limited liability aspects of your LLC are intact.
Remember that an LLC where the only members are two married individuals (that is, married to one another!), the LLC can be treated as a single-member LLC and thus have disregarded entity status.
Disregarded entity status means is that you don’t file a separate tax return for your LLC. The LLC does not pay taxes on the profits and those profits pass through to you personally. As a pass-through entity, you simply report your business income and expenses (all those deductions you’ve been tracking and keeping receipts for) on a Schedule C on your form 1040. Any remaining profits are considered self-employment income. Any losses would be considered self-employment deductions.
After completing your Schedule C, you’ll then complete a Schedule SE which will calculate your self-employment tax.
You pay approximately 13% FICA on the first $100,000 of your LLC’s net income–that is, income after subtracting all your business expenses. In addition to FICA, you’ll pay 2.9% Medicare tax on all your net income. This tax sounds extremely high, and it is.
However, it’s not as unfair to the self-employed as it sounds. All self-employed taxpayers are permitted to take a deduction on their total taxes in an amount that is equal to half of their self-employment tax.
Example: Suppose your single-member LLC business did $70,000 in revenue last year and had $20,000 in expenses. Your net taxable income (or profits) would be $50,000. You’d owe approximately 15% self-employment tax on the $50,000 net business income, or $7,500. In addition, you’d get a deduction on your regular Federal income tax return equal to half your self-employment tax, or $3,750.
The purpose of this is to place the self-employed in the same position with respect to FICA taxes as a corporate owner who paid himself a salary (the double tax for corporations comes in when the corporation pays a dividend to the owners–there’s no corporate double tax on salaries).
How Multi-Member LLCs calculate and pay Self-Employment tax
With a multi-member LLC, the IRS does not treat the LLC as a disregarded entity.
Instead, the LLC will file an informational partnership tax return on form 1065. I refer to this return as “informational” because the LLC will not actually pay any tax as an entity, as it is considered a partnership for income tax purposes. Net earnings of the LLC are considered pass-through taxation, and each of the LLC members share in the tax burden.
Instead, the purpose of the LLC’s tax return on IRS Form 1065 is simply to figure out the total amount of tax owed, and then each partner pays their share of the taxes. So, while each member will have two tax returns, income tax is only paid once. From this Form 1065 informational tax return, the LLC will issue K-1s, which tell each member how much profit or loss they will recognize.
Self Employment Tax Rates
Social Security (FICA) tax rate: 12.4%
(note: only the first $128,700 of your self-employment income is subject to FICA)
Medicare tax rate: 2.9%
This article on Self Employment tax for LLCs answers the following questions:
- How do I calculate self-employment tax for my LLC?
- Do I have to pay self-employment tax for an LLC?
- Are single-member LLCs treated differently when it comes to self-employment tax?