In 2013, self-employment tax (i.e. a tax on net earnings from self-employment) which consists of Social Security Tax (FICA) and Medicare taxes are imposed on LLC members, but not on S-Corporation shareholders. As a tax-planning strategy, an LLC may be wholly-owned by an S-Corporation. LLC earnings are distributed to the LLC member, S-Corporation. There is no self-employment tax on the S-Corporation/LLC distribution (a 2013 tax savings of $17,396).
In 2013, high earners face increased FICA/Medicare Taxes (Employer/Employee Share).
1. Social Security (FICA Tax), 12.4% tax on net earnings up to $113,700 ($14,099 annual tax);
2. Medicare Tax (Self-Employment Tax), 2.9% Medicare tax on unlimited net self-employment earnings up to $113,700 ($3,298 annual tax).
In addition, in 2013 high earners face additional increased taxes:
1. Medicare Tax (Net Investment Income), 3.8% tax for taxpayers with income over $200,000 (individual), $250,000 (husband and wife) on lesser of net investment income or modified adjusted gross income;
2. Medicare Tax (Earned Income), 0.9% tax on earned income (wages over $200,000 individual, $250,000 husband and wife). This tax is imposed on employee’s share of Medicare tax, and is disclosed on Form 1040.
3. Phase-out in itemized deductions, adds up to 1.19% to marginal tax rates.
Itemized deductions are reduced by 3% of adjusted gross income (AGI) over $250,000 for singles, $300,000 for couples, not to exceed 80% of total itemizations (medical expenses, investment interest deductions, casualty losses are all exempt). The phase-out is based on the amount of AGI and net taxable income (i.e. what is left after itemized deductions).
4. Personal Exemption, loss of exemption adds as much as 1.05% per exemption. Personal exemptions are reduced by 2% for each $2,500 of AGI over the $250,000/$300,000 threshholds, and disappear once AGI exceeds $372,500 (singles), $422,500 (couples).
As a tax-planning strategy, investment income may be lessened by “net-income” taxation. Tier #1, the LLC receives investment income, distributes net income (i.e. income less expenses) to the S-Corporation (member/manager), which in turn distributes their net income to the S-Corporation shareholders. The #2 tier distribution to the S-Corporation shareholder is subject to a lesser risk of an IRS tax audit (than an individual taxpayer) and with proper tax planning less additional tax due to the phase-out of the itemized deductions and personal exemptions.