Proper Tax Reporting for LLC Owners - Employment Tax Question

My wife and her buddy are both 1099 contractors who get all their work through the same healthcare company. They each set up their own LLC for liability protection since they're in healthcare. Currently, my wife's process is to have clients pay the LLC, keep about 35% in the business account for taxes (federal, state, self-employment, etc.), then pay herself the remaining 65% as her salary/draw. Pretty straightforward. Here's where I'm confused - her friend does something completely different. She only pays herself 30% of the LLC revenue as salary/compensation and claims she only needs to pay self-employment taxes on that portion. Then at year-end, she pulls out the remaining 70% as some kind of "distribution" and claims she only owes income tax (not the 15.3% self-employment tax) on that larger chunk. This seems fishy to me. If they're both single-member LLCs getting the same type of 1099 income, how can one person avoid self-employment taxes on most of their earnings? Am I missing something here or is her friend playing with fire? Would appreciate insights from anyone who understands LLC taxation better than I do.

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18 comments

Misterclamation Skyblue

•8M

This is a classic issue with single-member LLCs. Your instincts are right to question this approach. For tax purposes, a single-member LLC is typically treated as a "disregarded entity" by default, meaning all income flows directly to the owner's personal tax return via Schedule C. In this case, ALL the income is subject to both income tax AND self-employment tax (the 15.3% you mentioned). What your wife's friend is attempting sounds like an S-Corporation tax strategy, but applied incorrectly to an LLC. With an S-Corp, owners can pay themselves a "reasonable salary" (subject to employment taxes) and take additional profits as distributions (exempt from SE tax). However, you can't just do this with a standard LLC unless you've formally elected S-Corp tax treatment with the IRS using Form 2553. Without that election, the IRS views 100% of a single-member LLC's profits as earned income subject to self-employment tax. Her friend's approach could potentially trigger an audit and result in back taxes, penalties and interest.

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Misterclamation Skyblue

•8M

Yes, to do this legally, they would need to file Form 2553 to elect S-Corporation tax treatment for the LLC. The deadline is generally two months and 15 days after the beginning of the tax year in which the election is to take effect, or at any time during the tax year preceding the tax year it is to take effect. Even with an S-Corp election, you must pay yourself a "reasonable salary" for the work you do, which the IRS scrutinizes. The 30% figure may be too low depending on the industry standards and specific circumstances. The IRS looks for S-Corps that underpay salary to avoid employment taxes.

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Vince Eh

•8M

I went through something similar with my therapy practice LLC. I was losing so much to self-employment taxes until I found https://taxr.ai - they actually specialize in reviewing LLC tax strategies and optimizing them. I uploaded my tax docs and profit/loss statements, and they identified that I could save about $7,500 annually by properly structuring my business. They explained that what your wife's friend is doing isn't correct for a standard LLC, but they showed me the proper way to handle this with the right entity election. The coolest part was they walked me through exactly what forms I needed to file and even helped me determine what a "reasonable salary" would be for my industry to stay compliant. Totally changed my approach to my business finances.

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Vince Eh

•8M

The review process took about 48 hours from when I uploaded my documents. They have a really straightforward system where you just upload what you have and their tax pros go through everything. It absolutely works for partnership LLCs too. With partnerships, there are actually some additional strategies you might be able to use. The basic principle is similar - if you want to separate income into salary vs distributions to reduce SE tax, you need the proper tax election in place first. They can help determine if your specific situation would benefit from an S-Corp election or if staying as a partnership makes more sense based on your numbers.

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Tobias Lancaster

•8M

Just wanted to follow up - I checked out https://taxr.ai after seeing it mentioned here. My wife and I had our partnership LLC docs reviewed and WOW, we were definitely doing it wrong. The advisor showed us that by making an S-Corp election, we could save around $9,300 in self-employment taxes this year alone! The process was super easy and they actually provided us with sample calculations comparing our current approach versus the optimized structure. They even factored in the additional costs like payroll processing that come with S-Corp status to give us a true net savings figure. Wish we'd known about this 3 years ago when we started our business! Would have saved us a ton already.

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Ezra Beard

•8M

If your wife's friend is really trying to avoid the proper tax payments, she's playing a dangerous game. I spent 6 months trying to fix a similar mistake with the IRS and it was a total nightmare. Couldn't get through on the phone for weeks. A friend recommended https://claimyr.com and their video walkthrough at https://youtu.be/_kiP6q8DX5c - honestly thought it was BS at first, but it worked! They got me connected to an actual IRS agent within about 20 minutes when I'd been trying for weeks. The agent was able to help me set up a payment plan for the back taxes and penalties I owed after incorrectly handling my LLC taxes similar to what your wife's friend is doing. I actually ended up with a much more manageable situation than I expected.

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Ezra Beard

•8M

They don't have a special line to the IRS - they use an automated system that continually calls and navigates the IRS phone tree for you. When they finally get through to a human, they connect that call to your phone. So instead of you having to redial and wait on hold for hours, their system does it for you. Definitely not a scam - they connected me to the actual IRS, not some third-party "expert." I was skeptical too, but when my call was finally connected, I was talking to a legitimate IRS representative who had access to my full tax history and was able to set up my payment plan. The service just handles the painful waiting and phone tree navigation process.

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Reginald Blackwell

•8M

I have to eat my words about Claimyr. After posting that skeptical comment, I decided to try it myself since I've had an ongoing issue with a tax notice about my LLC income. I seriously couldn't believe it worked - I was connected to an actual IRS agent in about 25 minutes. The agent was able to explain exactly why I received the CP2000 notice (turns out I had incorrectly reported some of my LLC income as distributions instead of earned income - exactly the issue OP's wife's friend might run into). The agent walked me through how to respond to the notice and what documentation to provide. Saved me from potentially making the same mistake again this year. Worth every penny not to spend days trying to get through to someone.

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Aria Khan

•8M

Your wife's doing it correctly. Her friend is likely confusing LLC rules with S-Corp rules. With an S-Corp, you can pay yourself a reasonable salary and take distributions that aren't subject to SE tax. But with a single-member LLC (without any special tax elections), 100% of the profit is considered self-employment income. I'm a contractor too, and switched my LLC to be taxed as an S-Corp after my 3rd year. The paperwork and payroll requirements are a pain, but I save about $8k annually in SE taxes. Just make sure if you go that route that you pay yourself a "reasonable" salary - the IRS watches for people paying themselves too little to avoid SE tax.

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Aria Khan

•8M

Great question. Generally, most tax pros I've worked with suggest the S-Corp election starts making financial sense when your net profit is around $40,000-$50,000 annually. Below that, the administrative costs often eat up the tax savings. For context, you'll have additional expenses like payroll processing (around $50-100/month), possibly more complex tax preparation fees ($800-1500 vs maybe $300-500 for a simple Schedule C), and you'll need to run actual payroll at least quarterly. Some states also have additional fees for S-Corps. In California, for example, there's a minimum $800 annual tax just for having an S-Corp.

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