The SMLLC and the Family Payroll Tax Exemption

If you are a single-member LLC (SMLLC) reporting for tax purposes as a sole proprietorship, you may be interested in a recent payroll tax change.

An SMLLC is reported for income tax purposes as either a corporation or a proprietorship. A question came up in recent years on how to treat an SMLLC for payroll tax purposes. In August, 2007 the IRS issued final regulations requiring the SMLLC to be treated as the taxpayer for employment tax purposes. This meant that it had to get an identification number separate from its sole member, for example. These regulations became effective January 1, 2009.

This in turn raised the question on what to do with the family employment tax exemption. The family tax exemption allows a proprietor who pays his/her spouse or children the following:

·         For a child under age 18, unemployment, FICA and Medicare taxes will not apply

·         For a child over 17 but under 21, unemployment taxes will not apply

·         For a spouse, unemployment taxes will not apply

By treating the SMLLC as an entity distinct from the sole member, the parent was not employing the family member, at least technically. This threw-out the family employment tax exemption.

Talk about unintended consequences.

The IRS has now reversed course and has expanded the family tax exemption to SMLLCs – and has made the exemption retroactive to January 1, 2009. This could mean that amended payroll tax returns are in order.

Example: You operate as a SMLLC. You have 7 employees, which include your spouse, a child age 16 and a child age 19. What are the federal employment tax consequences?

a.       The child age 17 is exempt from FICA, Medicare and unemployment

b.      The child age 19 is exempt from unemployment

c.       The spouse is exempt from unemployment