LLC-SCorp to self - actually, does the corp pay payroll taxes?

Question

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.)

Answer 1

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.

Answer 2

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.)

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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.

Answer 3

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.