Are members of an LLC required to pay estimated tax and self-employment taxes on their share?

A Limited Liability Company (LLC) is a hybrid business form that combines the liability protection of a corporation with the pass through tax status of a partnership. According to IRS Publication 3402, a single member LLC is viewed under the same conditions as a sole proprietorship for the purposes of taxes. LLC’s with two or more members are viewed as a partnership. As with any business, the business owner does not withhold employment taxes from his earnings to account for employment taxes. Because of this, LLC members must pay self-employment taxes to cover their contribution to the Social Security and Welfare funds.

Single Member LLC

For the single member LLC, all proceeds made by the company, including those withheld by the owner for reinvestment, are considered profit. Expenses are written off and the federal tax percent of the remaining profits are due as self-employment taxes. This means that on top of paying income taxes for any salary taken by the member, he must also pay an additional tax for owning and running his own business.

Active Members of an LLC

When a multi-owner LLC is formed, the owners will typically define their percentage of the business for the purpose of share distributions at the end of the tax year. If all the members of the LLC are actively making decisions for and running the business, then the shares are traditionally divided equally among the members. For instance, there may be 5 members of an LLC, each receiving 20 percent of the profit distribution. In this example, because all of the members are actively making decisions for the business, they are all considered self-employed by the IRS. This means that each of them must pay self-employment taxes annually. However, the difference between the single member LLC and the active member LLC is that the active members only pay employment taxes on their percentage of the business. So, in the above example, each member pays employment taxes for 20 percent of the total profit earned. Bear in mind that the employment tax must be paid on profit earned regardless of actual distribution to members. So, even if your share is sitting in the bank for reinvestment, you must still pay self-employment taxes on that amount.

Silent Members of an LLC

The one exception to the self-employment tax rules are silent LLC members. A silent LLC member is someone who typically buys a share of an LLC for the purpose of gaining distributions, but does not make decisions for or in any way interact with the business. Silent members are not considered self-employed by the company, so they owe no self-employment taxes, regardless of owning a share. However, silent members are responsible for paying income taxes on any share distributions that they do receive from the company. So, if at the end of the year an LLC pays out a $30,000 distribution to their silent member, the silent member must include this distribution on their income taxes, but does not have to file an additional self-employment tax form.

Case Studies: Tax Obligations for LLC Members

Case Study 1: Single Member LLC

In this case study, we have John, the sole owner of an LLC. John is required to pay self-employment taxes on all the profits generated by the business, in addition to income taxes on any salary he takes.

Case Study 2: Active Members of an LLC

Let’s explore the situation of Sarah and Mark, who are active members of an LLC. Both Sarah and Mark actively participate in running the business. As active members, they are considered self-employed by the IRS and must pay self-employment taxes on their respective shares of the business’s profits.

Case Study 3: Silent Member in an LLC

In this case study, we examine the role of Mark, a silent member in an LLC. Mark has purchased a share in the LLC for distributions but does not participate in making business decisions. As a silent member, Mark is not considered self-employed and is exempt from self-employment taxes. However, he is still responsible for reporting and paying income taxes on any distributions he receives from the LLC.