Self Employment Tax

by Joe
(Los Angeles, CA, USA)

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.

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.