Three reasons to become a salaried employee of your LLC

Forming an LLC is not only important for liability protection, but, when structured properly, there can also be significant tax advantages. So, if you want to keep as much of your business profits as possible and limit the amount that you personally pay in taxes, an LLC can help you do just that.

LLCs are primarily governed by state laws and statutes, but from a federal tax perspective profits from an LLC ‘pass-through’ to the members or owners. This means, if you are a member of an LLC, you will report your share of the income received from the LLC as personal income and it will be subject to a significant amount of Self Employment tax which is in addition to your personal income tax rate.

But just by filing form 2553 with the IRS which allows you to elect to have your LLC taxed as an S Corp, you can significantly reduce your tax burden.

This choice is available to LLCs that adhere to these basic requirements.

- Your LLC is based in the US.
- There are less than 100 members in the LLC.
- None of the shareholders or members can be partnerships, corporations or non-resident aliens.
- The LLC only has one class of stock.
- And last, your LLC cannot operate in certain industries considered ‘ineligible’. Which are financial, insurance or a US-based international sales organization.

Owners of an S corp who work day-to-day in that S corp can be salaried employees of the S corp and this is exactly what you need to do to gain the tax advantages provided. You are an owner of the LLC and an employee of the LLC.

In order for this arrangement to provide you with any tax advantage, it is important that your salary from the LLC reflects a reasonable amount paid for the time and effort you put into your business.

As an employee you will have appropriate Social Security and Medicare withholding taken out of your salary and matched by your LLC. Then, when you receive profit distributions from the S corp as the owner, that income is not subject to Self Employment tax. Currently, the self-employment tax rate is 15.3%. But as an employee, your profit is not subjected to the Self Employment tax.

Obviously, using this strategy can significantly reduce the total amount of tax you will pay personally.

This is also an important aspect of making the business reflect the real costs of doing business. Too many entrepreneurs do not account for the value of the long hours that they commit to their business. Without an honest accounting of ALL costs of running your business, including your own efforts…your bottom line is not real…your books are simply not factual.

If you pay yourself a reasonable salary, your business will now have an honest set of books, and your P&L statement will reflect the real numbers for your business. You will know if the business is truly profitable and anyone who looks at your books will also know the true cost of doing business and the actual profitability of the company.

And remember, the withholding from your salary will go to your future retirement. You will be able to recoup this in the future as social security payments. This can be critical for a serial entrepreneur.

With the ups and downs of small business entrepreneurship, you may find yourself over 65 without income. In that case, you will be very happy to receive social security payments to help you recover and start another business.

Bottomline…form an LLC, elect S corp designation and make yourself a salaried employee as soon as you are able.