I am the manager partner in an LLC and the only active member. There are no employees in the company. To date the LLC has paid me a larger distribution than the other members as compensation for my duties and the other members have paid taxes on this additional money in proportion to their ownership in the LLC. The business is not a full time job for me. I work on behalf of the LLC in the evenings and on the weekends as I have a full time job which draws a salary, medical benefits, etc. during normal business hours.
Our LLC now wants to move me to a salaried position which will lessen the tax burden of the other shareholders. I are uncertain of how to pay taxes for the salaried compensation in this scenario. Can you share what options you see? Self-employment? Payroll taxes? Other?
We elected to file as an S-corp if this matters to the discussion.
Hi GMerr,
This very question has been a very big point for the IRS and many small businesses. Moving to be paid as an employee makes a lot of sense. The EIN of the S-Corp will be used as the payer. A good payroll company can also assist you with the process.
How to Pay Employer Federal Taxes
Reasonable compensation is an issue that has come up many times Paying Yourself Is a good walkthrough of what the IRS is assessing on whom should be paid what.
"Reasonable compensation
Because an officer of a corporation is generally an employee with wages subject to withholding, corporate officers may question what is considered reasonable compensation for the efforts they contribute to conducting their trade or business. Wages paid to you as an officer of a corporation should generally be commensurate with your duties. Refer to "Employee's Pay, Tests for Deducting Pay" in Publication 535, Business Expenses for more information. Public libraries may have reference sources that provide averages of compensation paid for various types of services. The Internal Revenue Service may determine that adjustments must be made to the income and expenses of tax returns for both the corporation and an individual shareholder if the officer is underpaid for services provided."
If you have been paying self employment on those distributions, you are probably not going to run into an issue. However you also must be careful not to potentially cause a problem on your S-Corp status.
Here is a link to a 2014 article that explains the issues involved of a partner being treated as an employee.
https://www.journalofaccountancy.com/issues/2014/aug/20149676.html