If you receive a 1099 for nonemployee compensation, or operate a sole proprietorship or partnership, you are probably paying too much in taxes. You may be able to minimize self-employment tax liability by utilizing the flexibility of an LLC's tax treatment. If you are not already organized as a business entity, doing so will allow you to write off certain expenses related to the business.
Elect to be taxed as an S corporation by filing Form 2553 with the IRS. Your company will remain an LLC and provide personal liability protection, but you will no longer be taxed under the default rules for LLCs. For federal tax purposes, LLC members will now be considered shareholders rather than partners, and will not be liable for self-employment tax on profit distributions.
Read More: How do I File Taxes for an LLC?
Pay any managers a minimally reasonable salary. The person or persons who manage the day-to-day operations of the business should be paid a salary that is commercially reasonable, which will be treated as ordinary income. If the managers are also members, they will be subject to self-employment tax on this income.
Complete Form 1120S. Though this form does not need to be filed, it will help you calculate the profits of the company. The manager's pay, as well as other legitimate business expenses, can be deducted before taxes. The remainder can be distributed as profit and reported on Schedule E of the individual owner's tax return.
An S corp must meet certain criteria, including having no foreign or business entity shareholders.
The ability to deduct business expenses from the company's income is a powerful way to reduce your overall taxes. Expenses that are partly personal and partly business-related can be deducted in the proportion to which they are legitimately related to the business (see Resources).
Joseph Nicholson is an independent analyst whose publishing achievements include a cover feature for "Futures Magazine" and a recurring column in the monthly newsletter of a private mint. He received a Bachelor of Arts in English from the University of Florida and is currently attending law school in San Francisco.