Best way to avoid social security and medicare taxes from huge sales income in an LLC.?

Question

I am in my first year as an LLC and I just closed a huge contract. My income from the contract will be about $450,000, while my expenses were about $250,000. I will have residual and normal income of about $8,000 per month after this closes.

I want to take out as much money as possible to pay off personal debt that I incurred while I was "out of work" and building the business. I also want to pay off other personal debt as well.

Therefore, I want to pay myself as much money as possible, but pay as little taxes as possible (of course). I primarily want to avoid social security and medicare tax. I understand I can't avoid the income tax. My wife helps me in my business, and I have two kids (both under the age of 10).

I have heard that if I pay myself the money as a distribution, then I don't have to pay SS and medicare taxes - but my distribution amount should not exceed my salary.

What is the best way to distribute this income and pay the least amount of taxes?

Thank

Answer 1

Excellent Question.

First, it depends upon the nature of the business. If the business is providing personal services, such as a physician, the majority of the net income would
be subject to social security and medicare taxes.

If, however, the nature of the business is of selling personal property, which this scenario sounds like, you do have an opportunity to avoid some social security and medicare tax.

The information that you provided lacks a crucial element. Are you a single member or multiple member LLC? If you are a single member LLC, then your
income and deductions are reported as a Schedule C - in that case, the majority of taxable income would be subject to self-employment tax (Social Security/Medicare).

Assuming you are a multiple member LLC (by the way, the IRS perceives that a husband and wife, even if they are listed as separate partners, they are considered as one entity), then your LLC is considered to be a "partnership".

As a "partnership", yes, the distributions to you, are not subject to tax. Neither
Federal or State Tax. These distributions to you, reduce the amount of capital
you have invested in the company. These distributions, a business
expenditure, reduce the amount of cash in the business, but, have no effect
on the bottom line (net profit).

As a multiple member LLC, the IRS will accept a "reasonable" amount of
"salary", subject to Social Security and Medicare taxes - what is reasonable?
In your case, it sounds as if you will make a profit of roughly $ 200,000, plus the residual income.

A reasonable salary might be 50%. Which means, you need to take a salary of about $ 100,000. $ 97,000 would be subject to Social Security and $ 100,000 for Medicare tax. The remaining $ 100,000 would not be subject to Social Security/Medicare.

A very nice benefit, by the way, is that the salary does not have to be paid throughout the year. You can pay the salary as a "bonus" just before the year
ends, and pay the taxes within the "threshold period" (refer to Form 941
instruction booklet); this bonus is considered to have been paid throughout
the year - vis a vis, the issuance of a W-2, and not subject to the underpayment penalty.

Another important consideration is how much you have contributed to Social Security in the past. If you have made a significant contribution to Social Security in the past, and if this salary would not have an impact on your retirement, then you would be able to reduce your bonus quite a bit.

It would be quite advantageous for you to consult a CPA on this.

Answer 2

Kodi, If are are going to be treated as an employee of the company (LLC), then you would be an employee. If you are to become a member you would not be on payroll. As an employee, if you complete a W-4 stating that you are exempt from taxes. They, at a minimum, have to withhold fica and Medicare. The LLC would have to match that when they make tax deposits or file the form 941 and pay the balance each quarter. If you are exempt from federal, you need to complete the W-4 of that state and see if you are exempt there also, Most likely, yes. Sounds like you did your homework. Let me know what kind of business you are getting into and accounting help.

Answer 3

A distribution from the business would definitely avoid the FICA and Medicare taxes. I have never heard that a distribution shouldn't exceed your salary. Your salary should be commiserate with what you do for the company. Your distribution would be based on what your overall share of the net profits from the business. Is this a sole proprietorship? I would really contact a tax accountant who can get a strong understanding of your business and both the federal laws and the tax laws in your state to walk you through the process.

Answer 4

If this is a single person llc, the income will flow directly from your schedule c to your 1040 (and schedule SE for the self-employment taxes).

There really is no legal way to avoid self-employment taxes (2x social security and medicare) unless you chose to be taxed as an S-Corp when the company was set up.

It is probably time to see a professional on this one.