LLC Taxes: How Single-Member and Multi-Member LLCs Are Taxed
Starting a business often involves forming an LLC. But LLC is a legal structure, not a tax classification. By default, the IRS ignores the LLC entity and taxes the income directly — which has significant implications for self-employment taxes. Understanding your options before you structure your business can save thousands per year.
LLC Default Tax Treatment
Single-Member LLC
By default, the IRS treats a single-member LLC as a disregarded entity — identical to being a sole proprietor. The LLC's income and expenses flow directly to your personal return on Schedule C.
The tax consequence: ALL net income is subject to self-employment tax (15.3% on the first ~$168,600 of net earnings in 2026, 2.9% above that). On $100,000 of net income: ~$14,130 in self-employment tax.
Self-employment tax applies because you're both the employer and employee paying Social Security and Medicare contributions.
Multi-Member LLC
By default, a multi-member LLC is treated as a partnership. Income passes through to each member's personal return via Schedule K-1. Each member pays self-employment tax on their share of active income.
The S-Corp Election: Splitting Salary and Distributions
An LLC can elect to be taxed as an S-corporation (file IRS Form 2553). The S-corp election doesn't change the legal structure — it changes how income is taxed.
How S-corp taxation works:
- The LLC pays you a "reasonable salary" as an employee
- Payroll taxes (employee + employer portion = 15.3%) are paid on the salary
- Remaining profits are distributed as pass-through distributions
- Distributions are NOT subject to self-employment/payroll taxes
Example: $150,000 net income
| Structure | Salary | Distribution | Payroll Tax | Total Effective Tax |
|---|---|---|---|---|
| Default LLC | N/A | N/A | $21,195 | Higher |
| S-corp election | $70,000 | $80,000 | $10,710 | ~$10,485 savings |
The savings come from the distribution portion avoiding the 15.3% payroll tax.
"Reasonable salary" requirement: The IRS requires the salary to be comparable to market rate for the role. You can't pay yourself $10,000 in salary and take $140,000 in distributions — that's an audit trigger. Industry standard: salary = 40-60% of net income, or market rate for the work performed.
When the S-Corp Election Makes Sense
Generally worth it at: $40,000+ in net self-employment income.
The trade-off: S-corp creates mandatory payroll processing costs:
- Payroll service ($50-150/month): ADP, Gusto, QuickBooks
- Additional accounting complexity: quarterly payroll taxes, W-2s, separate S-corp return (Form 1120-S)
Below $40,000 in net income, the payroll processing costs may exceed the self-employment tax savings.
Above $100,000-150,000: The savings are substantial and clearly worth the additional complexity.
Qualified Business Income (QBI) Deduction
The Tax Cuts and Jobs Act created a 20% deduction on qualified business income for pass-through entities (sole proprietors, partnerships, S-corps, LLCs) — Section 199A.
How it works: Up to 20% of your business net income may be deducted from taxable income, subject to limits.
Limits that phase in:
- Above ~$197,300 (single) / $394,600 (MFJ) in 2026: Restrictions apply based on W-2 wages paid and business property
- Specified Service Trades or Businesses (SSTB): Law, health, consulting, financial services, etc. — phase-out applies and the deduction is eliminated at higher incomes
Example: $100,000 net business income, below phase-out threshold
- 20% × $100,000 = $20,000 QBI deduction
- If you're in the 22% bracket: saves $4,400 in federal tax
The S-corp structure and QBI deduction interact in complex ways — consult a CPA to optimize the combination.
Self-Employment Tax Deduction
Half of self-employment tax is deductible on your personal return (Schedule 1, Line 15). This reduces your income tax on the amount paid, but not the SE tax itself.
Business Expenses
Track and deduct legitimate business expenses:
- Home office (regular and exclusive use)
- Vehicle (business miles at $0.67/mile in 2026, or actual expenses)
- Software, subscriptions, tools
- Professional development, books, courses
- Health insurance premiums (deductible as self-employed if no employer plan available)
- Retirement contributions (SEP-IRA, Solo 401k)
- Professional services (accounting, legal)
Retirement Accounts for LLC Owners
Self-employment unlocks powerful retirement options:
SEP-IRA: Contribute up to 25% of net self-employment income, max $69,000 (2026). Simple to set up, flexible contributions.
Solo 401(k): As both employer and employee, contribute:
- Employee: up to $23,500 (2026)
- Employer: up to 25% of W-2 wages (if S-corp) or net SE income
- Total: up to $69,000 (2026)
Solo 401(k) with Roth option allows Roth contributions at higher limits than a personal Roth IRA.
Example: S-corp with $150,000 salary, $70k salary
- Solo 401(k) employee contribution: $23,500
- Employer contribution: 25% × $70,000 = $17,500
- Total: $41,000 in pre-tax retirement per year
Common Mistakes
Mixing business and personal finances: Maintain a separate business checking account and credit card. Commingling funds is an audit risk and makes bookkeeping a nightmare.
Not making estimated quarterly payments: Self-employed income has no automatic withholding. Pay estimated taxes quarterly (April 15, June 15, September 15, January 15) or face underpayment penalties.
Taking too low a salary in an S-corp: "Reasonable compensation" is an IRS audit issue. Document how you determined your salary (industry surveys, comparable job postings).
Missing the S-corp election deadline: File Form 2553 within 75 days of the beginning of the tax year you want it to apply. Miss it and you wait until next year.
Work With a CPA
LLC taxation involves enough complexity — especially the S-corp election, QBI interaction, and retirement planning — that a CPA familiar with small business taxes pays for itself in the first year. The cost ($500-1,500/year for a small business return) is also deductible.
The default "just file Schedule C" approach works fine at low income. At $60,000+, tax planning becomes worth real attention.