A single-member LLC is generally subject to self-employment tax on its net business earnings when it uses the IRS default tax classification.
For the [TAX YEAR] tax year, the IRS generally treats a domestic single-member LLC as a disregarded entity for federal income tax purposes. The business activity is reported on the owner's personal tax return. If the LLC operates a trade or business, the owner is generally subject to self-employment tax in the same way as a sole proprietor.
Single-Member LLC Self-Employment Tax at a Glance
| Single-member LLC tax treatment | How business income is reported | Is the owner subject to self-employment tax? |
|---|---|---|
| Default disregarded-entity status | Usually Schedule C with Form 1040 | Yes, on net self-employment earnings |
| S corporation election | Form 1120-S, plus the owner's W-2 and K-1 | Payroll tax applies to reasonable wages; distributions generally are not self-employment wages |
| C corporation election | Form 1120, plus the owner's W-2 and possible dividends | Payroll tax applies to wages, not generally to corporate dividends |
The IRS defines self-employment tax as Social Security and Medicare taxes. It is separate from regular federal income tax.
How Self-Employment Tax Works for a Default Single-Member LLC
If you own a single-member LLC and have not elected corporate taxation, you generally report the LLC's business income and deductible expenses on Schedule C, Profit or Loss From Business. The resulting net profit is generally used to calculate self-employment tax on Schedule SE.
Self-employment tax is generally based on net earnings, not gross revenue:
- Business revenue is reduced by allowable business expenses.
- The remaining net profit is generally used to calculate self-employment tax.
- Personal withdrawals, or owner draws, do not determine whether the income is subject to self-employment tax.
- If the business has no net profit, it may not generate self-employment tax.
- If total net earnings from self-employment are at least $400, the IRS generally requires Schedule SE.
Example
Assume a single-member LLC has:
- $100,000 in business revenue
- $30,000 in deductible business expenses
- $70,000 in net profit
The owner generally reports the $70,000 profit on the owner's federal tax return. The owner generally owes:
- Regular federal income tax on taxable income
- Self-employment tax on applicable net earnings from the business
Leaving the $70,000 in the LLC's bank account does not remove it from self-employment tax. The tax treatment generally depends on the LLC's net business earnings, not on how much money the owner withdraws.
Does an LLC Owner Pay Self-Employment Tax on an Owner Draw?
Usually, the owner draw itself is not a separate wage payment. The LLC's net business profit is generally subject to self-employment tax.
A default single-member LLC owner is generally not treated as an employee of the LLC for federal income tax purposes. The owner is treated similarly to a sole proprietor and is taxed on the LLC's net earnings from self-employment.
For example, if the LLC earns $80,000 in net profit and the owner withdraws only $20,000, the remaining $60,000 generally does not escape self-employment tax because it stays in the business.
Can an S Corporation Election Reduce Self-Employment Tax?
Yes, an S corporation election can change how employment taxes apply, but it does not eliminate payroll taxes or guarantee tax savings.
An eligible LLC can elect to be taxed as an S corporation. An owner who performs services for the S corporation generally must receive reasonable compensation as wages. Those wages are subject to payroll taxes. The S corporation may also make shareholder distributions, which generally are not treated as wages for employment tax purposes.
The IRS may reclassify distributions as wages if the owner provides substantial services but reports little or no salary. Factors relevant to reasonable compensation include:
- The owner's duties and responsibilities
- Time spent working in the business
- Training and experience
- Compensation paid to other employees
- Comparable pay for similar work
- Whether business revenue comes mainly from the owner's personal services or from employees, equipment, or capital
An S corporation election may be worth evaluating when a profitable business can pay reasonable wages and still have profit to distribute. The business must also handle payroll, employment tax filings, accounting, and more tax-return requirements.
What Income May Not Be Subject to Self-Employment Tax?
Some income connected with an LLC may receive different treatment. The result depends on the activity and the owner's involvement.
Potential categories include:
- Rental real estate income that is not treated as income from a real estate business
- Investment income
- Certain passive activities
- Income from a business in which the owner does not materially participate
- Corporate wages and distributions under an S corporation
These categories depend on the facts. Rental activity, for example, may be reported on Schedule E rather than Schedule C, but rental income can become subject to self-employment tax in specific circumstances.
What Forms Does a Single-Member LLC Use?
A default single-member LLC owned by an individual commonly uses:
- Form 1040 for the owner's federal individual tax return
- Schedule C to report business income and expenses
- Schedule SE to calculate self-employment tax when required
- Estimated tax payments when withholding is not enough
The LLC may also need its own EIN for employment tax reporting if it has employees, even though the LLC's business income is reported on the owner's personal return.
Bottom Line
A default single-member LLC is generally subject to self-employment tax on its net business earnings. The LLC's legal liability protection does not, by itself, remove that tax.
An LLC owner may consider an S corporation election once the business has consistent profit. The owner must still receive reasonable wages and follow payroll and corporate tax rules. Compare potential payroll-tax savings with accounting, payroll, filing, and compliance costs before making the election.