IRS Reasonable Executive Compensation

LIMITED LIABILITY COMPANY

A limited liability company (LLC) is NOT a separate tax entity like a corporation. An LLC is what the IRS calls a "pass-through entity," like a partnership or sole proprietorship. All of the profits and losses of the LLC "pass through" the business to the LLC owners. The owners report this information on their personal tax returns.

The LLC entity does NOT pay federal income taxes, but some states charge the LLC a tax at the entire level. A main advantage of an LLC is that its owners receive the same protection from liability as corporate stockholders.

Self-Employment Tax

LLC owners aren't employees — they're considered self-employed business owners. So, contributions to the Social Security and Medicare systems are NOT withheld from their paychecks. Most LLC owners have to pay the self-employment tax directly to the IRS (as illustrated before for a partnership).

The current rule states that any owner who works in or helps manage the business must pay this tax on their distributive share. However, owners who aren't active in the LLC — that is, those who have merely invested money but don't provide services or make management decisions for the LLC — may be exempt from paying self-employment taxes on their distributive share. The regulations in this area are a bit complicated, but if the owner actively manages or works in the LLC, they can expect to have to pay the self-employment tax on all LLC profits allocated to them.

Corporate Taxation

Any LLC can elect to be treated like a corporation for tax purposes. By filing IRS Form 8832 an LLC is taxed as a C-corporation. After making this election, profits are taxed separately at the corporate rate of 21%. The owners don't pay personal income taxes on corporate profits. In addition, an LLC may opt to file IRS Form 2553 instead of Form 8832 and will be taxed as an S-corporation.