Final answer:
S corporation shareholder-employees and LLC members receiving guaranteed payments and business income allocations are subject to different FICA tax burdens. The analysis changes if the owners are not actively involved in the entity's business activities, as they may be subject to a different tax rate.
Step-by-step explanation:
When comparing the FICA tax burden of S corporation shareholder-employees and LLC members receiving guaranteed payments and business income allocations, there are some key differences. S corporation shareholders who are also employees are subject to FICA taxes on their wages, including both the employer and employee portions of Social Security and Medicare taxes. These taxes are withheld from their paychecks as well as being paid by the corporation.
On the other hand, LLC members who receive guaranteed payments are considered self-employed and are responsible for paying both the employer and employee portions of FICA taxes as well as self-employment taxes themselves. The allocation of business income to S corporation shareholders and LLC members is also treated differently for tax purposes.
In an S corporation, the shareholders' share of business income is allocated and taxed based on their ownership percentage, regardless of their actual involvement in the business's activities. In an LLC, the members' share of business income is allocated and taxed based on their operating agreement, which may take into account their involvement and contribution to the business activities.
If the owners of the entity are not actively involved in the business activities, the analysis changes in terms of the self-employment tax. If the owners are not actively involved, their guaranteed payments or business income allocations may be considered passive income and subject to the Net Investment Income Tax (NIIT) instead of the self-employment tax.
The NIIT is an additional 3.8% tax on certain types of passive income, including income from partnerships, S corporations, and LLCs. It does not apply to active trade or business income. Therefore, if the owners are not actively involved in the entity's business activities, they may be subject to a lower tax burden.