In the USA. Here are the two common scenarios for the self-employed:

A. Joe makes 100,000 over the year. It's paid to him as 1099 payments from his various clients. Joe pays the many taxes on that.

B. Joe makes 100,000 over the year. He has an LLC as SCorp (or maybe an SCorp per se). The clients pay $100,000 to the entity JoeCorp. JoeCorp pays Joe a certain salary (it might be the whole 100,000, or, it might be (let's say) half of that and the rest is taken as profit distribution, not relevant here).

So, JoeCorp (his LLC) pays Joe say $50,000.

In fact: does JoeCorp have to pay "payroll taxes" on that??

Does it perhaps make a difference if it is an LLC with S-Corp election v. S-Corp?

(I realize there are many questions on here about "1099 v. corp" .... but I've never really understood this and can't seem to google it up.)


In fact: does JoeCorp have to pay "payroll taxes" on that??

Yes. Any shareholder of an S-Corp with greater than 2% ownership must take reasonable compensation from the S-Corp as a W-2 employee, and payroll taxes apply as they would with any employee. The tax-savings of an S-Corp come from not having to pay payroll/self-employment taxes on the distributions that are in excess of the 'reasonable compensation'.

Does it perhaps make a difference if it is an LLC with S-Corp election v. S-Corp?

No. To the IRS, LLC doesn't mean anything, LLC's are taxed as one of the following IRS business classifications: sole-proprietorship, partnership, S-Corp, C-Corp.

  • fantastic info as always. this must not be the internet :) – Fattie Apr 2 '18 at 16:33
  • Why would your customer pay you or your LLC in excess of the "reasonable compensation" for that job? – Harper Apr 2 '18 at 21:43
  • @Harper Most typically because they don't need someone full-time year-round, so it is more economical to pay me a much higher hourly rate for a shorter term. – Hart CO Apr 2 '18 at 21:52

As a 1099 contractor, the employee pays both halves of his FICA/social Security/Medicare tax (7.65% per half). As employee of his own S-corp, C-corp or LLC, the employee pays half and the employer pays half. So you end up paying the same taxes.

I would like to take a moment to euthanize the trope of "wrap myself in a corporate shell and lower my salary to reduce tax". Every tax authority knows this trick. It goes without saying that obvious tricks are obvious.

So yeah, the tax authorities are going to have a problem with you taking a $50,000 salary for a $100,000 job -- if it lowers your tax - and if it doesn't, why do it? (well there are other reasons: And they don't care whether you say "tomayto" or "tomahto" if the tax is the same.)

I'm getting beat up in comments for something I never said: that all distributions from that corporate shell must be tax fraud. First let me point out that if your customer hires you as an employee, it has very high HR expenses with things like a competitive healthcare plan, their half of FICA, unemployment compensation risk, endless paperwork, compliance, yadayada. Just think of all their sexual harassment related costs. They don't hire you 1099 to "make you more money". They hire you 1099 to spend less to hire you. And they don't pay you more if your last name is "LLC".

So the one place your LLC can create cash is by hiring you at a proper W-2 salary, and then being more efficient at those high HR costs. Get a cheapie Obamacare Bronze plan. Unemployment? HA! Spend evenings and weekends doing paperwork. This "created value" becomes surplus cash in the LLC and is distributable.

So the corporate shell allows you to correctly reclassify the difference between "competitive W-2 salary" and "competitive 1099 earnings" as not salary (fair enough, if you think about it) and lets you profit by efficiency.

One more hitch. Any bona-fide corporate entity must retain enough internal cash-on-hand to satisfy likely liabilities. So you can't distribute it all, some money will be tied up. Of course, you can just drunk-stumble through all this corporate stuff and probably get away with it, but that's not a correct answer.

  • This assumes $50k is not a reasonable salary for the type of work being done, it could well be reasonable. Even if 80-90k is what is reasonable, shielding 10-20k from payroll/self-employment taxes is significant. – Hart CO Apr 2 '18 at 17:32
  • Harper, I really appreciate the point. (Indeed note that it says in the question "the salary part might be 50, might be 100.) I just wanted to clarify if in such a situation the Corp has to pay payroll taxes: answer seems to be yes. – Fattie Apr 2 '18 at 17:56
  • @TTT Thanks for catching that plain error, and for the correct amount, yes that sounds right. – Harper Apr 2 '18 at 18:30
  • @HartCO The problem is that the knife cuts both ways. If it's significant, then it's significant to the taxing authority as well. As an employer you'd need to argue you could hire anyone for that wage. As an employee you'd need to justify why you can't get a better job elsewhere. "I get dividends in this firm" is admitting "those dividends are part of my compensation" and fails. – Harper Apr 2 '18 at 18:36
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    @Harper How many successful businesses earn just enough to cover wages? Distributions from an S-Corp are expected by the IRS, and them being significant doesn't make them invalid. – Hart CO Apr 2 '18 at 18:41

Yes, an S-Corp (or LLC treated as an S-Corp) pays FICA on all W-2 wages. Some other important notes though:

JoeCorp pays Joe a certain salary (it might be the whole 100,000, or, it might be (let's say) half of that and the rest is taken as profit distribution, not relevant here).

Actually, the amount of profit distribution might be extremely relevant in the case when the salary is less than a reasonable amount. For example, suppose a single owner S-Corp has $100K in income before paying any salary, and that a reasonable salary for the owner's job is deemed to be $80K. If the owner takes $30K in salary (or anything less than $80K) and the remaining $65K-ish in distributions, there is an increased risk of getting audited, and paying a penalty as a result. But if the owner takes $30K in salary (or anything less than $80K) and doesn't take any distributions, there is much less risk of an audit. The reason is if you don't take any distributions, then it isn't possible for the IRS to claim you were trying to avoid payroll taxes for that particular year. I'd be careful though, since based on that statement alone you might be tempted to take this to an extreme by taking a small salary and no distributions for many years, and then paying the reasonable salary or even maxing out SS (by taking salary of more than $128,400) and distributing the rest (say $500K or more) all at once. I suspect this too could trigger an audit but it would be a much harder case for the IRS to make that this was your intent all along.

Also, I think it's important to point out that the FICA savings available to an S-Corp works best when the following statements are both true:

  1. The S-Corp has more income (profit) than the reasonable salary should be. Until this is true you shouldn't be taking much money in the form of distributions.
  2. The reasonable salary is less than the SS max. The thinking here is that once you hit the SS max, you are only saving between 2.9% and 3.8%, as opposed to the 15.3% you save before you hit the SS max.
  • Thanks for that TTT. Again, the "reasonable salary" is certainly a hot issue and a complex one. Here I really just wanted to clarify if the corp indeed pays FICA / payroll tax on the "salary" section!! – Fattie Apr 2 '18 at 19:55
  • What does SS stand for? – papiro Sep 24 '18 at 6:30
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    @papiro - SS = Social Security – TTT Sep 24 '18 at 6:53
  • Hmmmm, that's what I was thinking, but I doubted my understanding when I saw "SS max" because I didn't understand what that was. Is it the max amount of SS tax you can pay based on an upper limit to the percentage range an income bracket can put you in? – papiro Sep 24 '18 at 16:47
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    @papiro yes. You only pay SS on the first X amount of your salary. In 2018 X=$128,400. More info here: ssa.gov/oact/cola/cbb.html – TTT Sep 24 '18 at 17:07

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