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SMLLC CPA provides Self Employment Tax example on Schedule C | SMLLC tax trap

SMLLC CPA Self Employment Tax on IRS Schedule C

Gary Bode, CPA: sometimes Self-Employment tax surprises the SMLLC’s Member in the first year of operation. (910) 399-2705.

SMLLC CPAs deal with many issues on Schedule C. But there’s a common tax trap for SMLLCs: self-employment tax. Especially in the first year of operation. Self-employment tax is Schedule C’s version of Social Security Tax and Medicare Tax. Note it doesn’t include federal income tax. I’ll give an example of Schedule C preparation for income and self-employment tax that demonstrates this common trap.

SMLLC Self Employment tax on Schedule C – typical first tax year trap overview

I’ve seen many SMLLC Members shocked at self employment taxes on their Schedule C profit. Why?

  • The Member usually hires a SMLLC CPA at the end of the first year of operation.
  • In 2013 self-employment tax is 15.3% of your net profit. That’s a big impact, especially if it comes as a surprise. I’ll give a 2012 example below. In 2012 the rate is 13.3%.
  • The Member generally doesn’t take a paycheck out the SMLLC in the first year of operation. Sometimes the Member just pays personal expenses through the SMLLC. Sometimes they take Draws where the Member just writes a check to him/herself. Draws have the advantage of avoiding payroll administration.
  • In the first year of SMLLC operation, Draws can delay dealing with both self-employment and income tax payment until preparation of Schedule C.
  • The Member usually thinks of Draws as a distribution; only subject to potential income tax when the SMLLC CPA prepares Schedule C. They forget or suppress the self-employment tax.
  • Since new SMLLCs usually don’t have large profits in the first few years, the Draws seem like tax-free money. In our example below, the income tax is indeed zero.
  • The Member generally doesn’t make estimated tax payments for Form 1040 the first year of SMLLC operations. This further enhances the illusion of tax-free money.

In the first year, Schedule C doesn’t have a huge impact on the Member’s income tax due. And the Member sort of expected some income tax. But watch what happens in the example below for self-employment tax.

Income and Self-Employment Tax Example on IRS Schedule C

Schedule C looks easy, probably because it doesn’t require a Balance Sheet. But there are many potential traps besides self-employment tax. Ask your SMLLC CPA about specifics. If you don’t have a SMLLC CPA, consider calling us for a free “get to know you” consult at (910) 399-2705. Our virtual office makes it easy to deal with us regardless of where your SMLLC does business.

Example Parameters

  • I’m assuming the SMLLC had no payroll for the year, just Draws by the Member. Or I assumed the Member paid personal expenses through the SMLLC.
  • For the income tax part of the example, I’m assuming the Member is filing Form 1040 with Head of Household status with two dependents.
  • The SMLLC is the only source of income for 2012.
  • Line 31 of Schedule C: here I’m assuming your SMLLC had a net profit of $20,000, just to keep the math simple.
  • The $20,000 on Line 31 of the SMLLC’s Schedule C is what the Member pays income and self-employment taxes on, even if the Member took less Draw than that during the year.

Cash out to the Member for the year seldom matches the “paper” profit on Schedule C.

Income tax logistics

  • The $20,000 profit goes to two places on the Member’s Form 1040 tax return.
  • The first is line 12 of Form 1040 where it becomes gross income.
  • Following the $20,000 down on Form 1040, through adjustments to gross income, the standard deduction and three exemptions, the $20,000 of gross income becomes $0 of taxable income.

The $20,000 of Gross Income disappears on Form 1040 leaving Taxable Income at zero, with no income tax due for the year.

Self Employment Tax

  • The $20,000 SMLLC profit from Line 31 on Schedule C also goes to Line 2 of Schedule SE.
  • The $20,000 on Schedule SE turns into $2457 of self-employment tax, even though there was zero taxable income.
  • The $2457 appears on Line 56 of Form 1040 in the other taxes due.

So, the Member of the SMLLC owes $2457 of taxes for the year, all of it self-employment tax.

Additional Notes

  • In this example, there would have been some Earned Income Credit to offset the tax bill, but I think I’ve demonstrated the self-employment tax trap.
  • Hopefully the Member had an SMLLC CPA to warn her of the self-employment tax and/or helped setup estimated tax payments for her.
  • A  Member of a SMLLC filing Schedule C usually makes estimated tax payments during the year, or, faces under payment penalties after filing the tax return. If the Member has some formal paychecks, the estimated tax payment requirements decrease.

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