Saving Payroll Taxes in Limited Liability Company Structure

Question:  I operate a business as a limited liability company which I am considering converting to an S corporation given the recent increase in the Social Security wage base.  I am not certain I want to forego the liability protection I enjoy from limited liability company status but do not want to pay more payroll taxes than I am already paying.  Is there a preferable alternative?

Answer:  The recent increase in the Social Security wage base represents one of the largest increases in recent years.  Effective January 1, 2017, the Social Security wage base increased from $118,500 to $127,200 meaning the first $127,200 of wages will be subject to Social Security or FICA taxes, 7.65% imposed on each of the employer and the employee.

S corporation owners often minimize this tax obligation by decreasing their compensation and receiving S corporation distributions which are not subject to payroll taxes.  The IRS has challenged arrangements which it deems abusive where S corporation owners are paid unreasonably low compensation and receive meaningful S corporation distributions.  There are no specific guidelines on when an S corporation owner will be deemed to be undercompensated but taxpayers are cautioned to be reasonable in decreasing their compensation and paying S corporation distributions so as not to trigger an IRS challenge.

Many business owners operate their businesses as LLCs for liability protection purposes. Creditors of LLC members have more limited rights to obtain control of businesses operated in the limited liability company format than creditors of shareholders of businesses operated as corporations. Unlike the situation with S corporation owners, payments to LLC owners who are actively involved in their businesses are subject to payroll taxes, whether directly paid as remuneration for services rendered or paid as LLC distributions.

Rather than choose between operating your business as an S corporation or a limited liability company, you can accomplish both of your objectives within your existing LLC structure. Your business can remain an LLC but elect S corporation status. While the business would be characterized as an S corporation for Federal tax purposes, the company will be treated as a limited liability company for State law purposes, thereby affording the company owners the creditor protection LLC owners enjoy.  As an S corporation for Federal tax purposes, you can structure your compensation in a manner which will reduce your payroll taxes.

A careful analysis of all applicable tax issues must be undertaken before your company changes its tax status. You must also be certain that your LLC structure satisfies all of the S corporation requirements. Only individuals, qualifying trusts, and other specified organizations are permitted owners of the entity. There must only be one class of stock issued. While generally not an issue with most S corporations, there cannot be more than 100 owners.  Assuming these and other requirements are satisfied, your LLC can elect to become an S corporation.

There are of course other factors which must be considered.  If you reduce your salary below the $127,200 threshold, the decrease could ultimately impact your Social Security benefits.  A reduction in your compensation could also decrease your share of contributions the company makes on your behalf to profit sharing and other company-sponsored retirement plans. Likewise, any other company benefits which are based on your salary such as group life insurance could be impacted by your compensation decrease. If none of these factors negates your desire to operate as an S corporation, then an S corporation election by your LLC may be the optimal choice for you.


The Tax Corner addresses various tax, estate, asset protection and other business matters.  Should you have any questions regarding the subject matter or if you have questions you want to be answered, you may contact Bruce at (312) 648-2300 or send an e-mail to

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