The SE (Self-Employment) Tax Danger of Forming an LLC
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With the ease and low expenses of forming an LLC, they are quickly becoming the entity of choice of many small business owners. However this type of entity can have some serious drawbacks if you simply form it without seeking some expert advice.
One of the more common mistakes I have been seeing is individuals forming LLCs and assuming they are corporations. In fact they are not taxed as corporations if formed by one individual and instead are treated as an ignored entity for tax purposes. Further the income they generate gets taxed on your personal tax return on Sch C and is subject to SE (Self-Employment) Tax. There are some circumstances where this does not apply, but generally if you run a business with the intention of generating a profit SE Tax applies.
So what is the big deal with SE Tax. Well this is the Social Security (6.2%) and Medicare (1.45%) (also known as FICA Taxes) that are normally deducted from your regular paycheck……..only doubled. You might ask why are they doubled. Well as a self-employed individual you are responsible for the employee and EMPLOYER (same as amount as the employee) share of FICA. No wait it gets worst. Unlike your regular income taxes, SE tax is not reduced by itemized deductions or tax credits.
So how is it calculated? You take your Sch C net income and multiply it by 92.35%. This is your net earnings from self-employment. Next multiply this amount by 15.3% and your have your SE Taxes due. The only real benefit is that you get to deduct 1/2 of the self employment taxes as a deduction on your 1040. But remember this simply reduces your taxable income, this is not a tax credit. You then add this tax with your regular income tax liability to arrive at your total tax liability. SE Tax in many cases can easily equal or exceed your regular income taxes, and if you do not plan correctly can lead to a huge tax headache at year end especially if you were expecting a refund.
So what can you do? My best advice is to contact me and for FREE I will tell you some of the options you have at your disposal. I can reached at (443) 927-9161 (MD), (703) 637-9881 (DC & VA), or by email at travis@ramlcpa.