Self-employment tax

Definition

The Social Security and Medicare tax an owner pays on their own business income.

Why It Matters

How the business is taxed decides who pays it. An LLC member owes it on the whole distributive share, while an S corporation owner splits the money into a reasonable salary, which carries payroll tax, and a distribution, which does not. The choice is not free: the salary has to be defensible and the payroll adds administration. Model both before closing, because the same business pays the same person two different amounts depending on an election made on paper.

In numbers: On $120,000 of net business income, an LLC member owes self-employment tax on the full amount, while an S corporation owner paying themselves a $70,000 salary carries payroll tax on $70,000 and takes $50,000 as a distribution.