Are LLC members taxed?

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Question:

We are considering changing our business from a corporation to a limited liability company. Are LLC members considered employees who are subject to withholding taxes and self-employment taxes?

Answer:

Generally, LLC members are treated like partners (or, in a one-owner LLC, like a sole proprietor). In other words, an LLC member's share of profits is usually not considered wages and is not subject to withholding. Each LLC member simply reports his or her share of LLC profits as income on the member's individual income tax return and pays estimated taxes in quarterly installments.

But an LLC member who is active in the business -- like a partner in a partnership -- has to pay self-employment taxes on his or her share of LLC profits. You can deduct half of what you pay for self-employment taxes as a business expense.

The self-employment tax situation for LLC members has been a subject of controversy and temporary regulations, and the dust has not yet settled around many of the issues. To protect yourself, especially if you are not an active member of the LLC and don't plan on paying self-employment taxes, you might get an opinion from a local tax expert -- preferably one who is willing to argue his or her opinion to IRS officials, if it comes to that.

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