TAX

LLC Taxes

Forming a limited liability company (LLC) can be a great choice for many entrepreneurs. LLCs provide their owners (members) with the best features of sole proprietorships and corporations. Like sole proprietorships, LLCs have few corporate formalities and owners are generally taxed at the personal level. Like corporations, LLC's limit the personal liability of each member and create a corporate veil between the business and its owner(s). Further, LLCs offer owners a number of options for how they can be taxed (individual, partnership, C corp, S corp) and divide business profits. While there are usually some expenses associated with setting up an LLC, the benefits this business structure can provide usually far outweigh its costs. Individuals and small business owners alike should seriously consider the LLC before accepting the unlimited liability of a sole proprietorship or formalities of a corporation.

REAL ESTATE AGENT

Caroline is a new real estate agent and close friends with Jing, a sole proprietor real estate agent who recently lost everything after a buyer sued her for failing to disclose information about a dangerous home. Per Jing's advice, Caroline formed an LLC so if the time comes when her business faces litigation, Caroline can rest easy knowing that in most cases her personal liability will be limited.

PHOTOGRAPHER

Shari is a freelance photographer who has organized her business as an LLC. Last year her firm had $45,000 of income. When Shari prepares her taxes she would report her business income on her Schedule C (since she is a single member LLC) and pay individual income tax and self employment tax on her business income just as a sole proprietor would.

PROFESSIONAL SERVICES

Mike is an architect who conducts business through his single member LLC. Last year Mike's Schedule C business profit was $120,000 and he paid himself $75,000 in distributions. Since LLC members pay tax on business earnings, not distributions, Mike would report $120,000 of gross income on his Form 1040 and calculate his income taxand self employment tax liability based on that amount.

ENTREPRENEUR

Kim is an entrepreneur with a single member LLC. After doing some research, he noticed that corporate tax rates were lower than individual tax rates. To prevent his undistributed income from being passed through to him to be taxed at a higher rate, he decided to complete Form 8832 and pay tax as a C corp instead of a sole proprietor. Accordingly, Kim would need to report his business income on Form 1120. Note however that by making this election, Kim would not be able to treat the distributions he took throughout the year as self employment income, which has additional tax implications.

AUTHOR / SPEAKER

Jerry, a non-fiction historian / author, recently partnered with Julia, a professional editor. They organized their business as an LLC and agreed to split profits 50/50. At the end of the year their business had $80,000 of income. Since their LLC has more than one member, they would need to file taxes for the business as a partnership and complete Form 1065. The partnership would then issue Jerry and Julia K-1's (like a W-2 for owners) showing each received a $40,000 share of business profits. They would then each report their $40,000 share of profits from the LLC on their respective Form 1040 and pay self employment taxes on their profit allocation.

WHAT TO KNOW BEFORE FORMING YOUR LLC

As a member of an LLC, your share of business income is taxed at personal income rates. This is because LLCs are so-called "pass-through" entities, which are businesses without a separate tax rate. Business income "flows" or "passes" through to the personal level before being taxed. LLC owners, like other pass-through entities, are responsible for both income and self-employment tax (the employee and employer portion of Social Security and Medicare contributions). The 2017 Tax Cuts and Jobs Act established a new tax deduction available to taxpayers with business income, referred to as the "business income deduction". This deduction effectively lowers the tax rate for millions of small businesses and self-employed taxpayers. The deduction is up to 20% of business income after deductible expenses, but can be limited or disallowed by various factors like total taxable income and type of business.
If you are a member of an LLC your personal liability for your business's obligations and actions is limited, even as a sole owner. Typically, only your investment will be at risk unless you fail to put enough money into your business, you commingle personal and business assets or you engage in fraudulent behavior.
To form an LLC typically you will need to 1) file articles of organization, which contain basic information like who the members in your business are, your business name, your business address, etc. 2) create an operating agreement to outline what your business does, how profits will be split (if you have partners), how long your business can exist, etc. and 3) pay a fee. Remember though, LLCs are governed by state statutes so your specific requirements may vary depending on where your business is organized.
If you are organized as an LLC, to report your business activity you should file: Schedule C if you are the only member, Form 1065 (partnership) if there is more than one member, Form 1120 if you have elected to be taxed as a C corp or Form 1120S if you have elected to be taxed as an S corp.
If you are organized as an LLC, you have the option of choosing to be taxed as a corporation. While most entrepreneurs won't benefit from being taxed as a C corp(Form 8832), some may benefit by electing to be taxed as an S corp (Form 2553). If you make the S election, you may be able to save on taxes while still receiving all of the legal benefits provided by your LLC. This can be a complicated decision so you should speak with your tax advisor to determine if making the S election makes sense for you.

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