Under current law, employee-owners of single owner limited liabilty companies are taxed for both income tax and employment tax purposes as self-employed sole proprietors who pay estimated taxes rather than employer withholding taxes, and who pay the "self-employment tax" in lieu of FICA. The dollar amount of the tax is essentially the same in the case of an active employee-owner. But, withholding has benefits over estimates taxes for workers, because it allows them to make big last minute tax payments while avoiding late payment penalties, and it can be inconvenient in an entity with multiple employees to have to put everyone except the CEO on the payroll, while having a separate system for the CEO. The LLC conducts business under the CEO's social security number, and when employment or excise taxes don't get paid, the CEO gets a notice personally for the deficiency. It has issues, but it is simple. A proposed change in the law, allegedly motivated by collection difficulties and confusion, would make this entity only "sort of disregarded", as it would exist for some purposes, but not others, under the tax code.
Under the proposed regulations the LLC would be treated like a corporation for purposes of employment taxes on employees other than the owner, federal excise taxes and bankruptcy, while still be treated like a sole proprietorship for purposes of the CEO's compensation and income tax purposes.
LLC would be liable for income tax withholding, as well as FICA and FUTA taxes. LLC would have to file under its name and tax ID number the applicable Forms in the 94X series, for example, Form 941, "Employer's Quarterly Employment Tax Return," Form 940, "Employer's Annual Federal Unemployment Tax Return," file with the Social Security Administration and furnish to LLC's employees statements on Forms W-2, "Wage and Tax Statement;" and make timely employment tax deposits.
[The employee-owner] is self-employed and subject to self-employment tax on his net earnings from self- employment with respect to LLC's activities. [He] is not an employee of LLC for employment tax purposes. Because LLC is treated as a sole proprietorship of A for income tax purposes, [he] would be entitled to deduct trade or business expenses paid or incurred with respect to activities carried on through LLC, including the employer's share of employment taxes imposed under Code Sec. 3111 and Code Sec. 3301 , on his Form 1040, Schedule C.
(quote from an Research Institute of America update).
It just sounds more complex to me. The system for regulating entities has evolved so much from its roots that it really needs to start over from first principles. Until then, figuring out how to organize businesss entities to the best advantage of the owners will remain a game for lawyers and accountants.