By Tricia Joyce
Starting a small business can be an exciting, if sometimes stressful, journey. While finally being able to be your own boss is definitely a perk, running your own business isn’t always easy.
One of the greatest hurdles that entrepreneurs are often underequipped to deal with is taxation. How much should you be paying per year, and what are the forms and processes? In our previous post ‘Corporation Tax – A Guide for Small Businesses’, we discussed the ins and outs of corporation taxes and other basic information. Today, we’re going to look at the specifics of paying tax as a Limited Liability Company (LLC).
Benefits of an LLC
Why choose to register as an LLC? Well, most entrepreneurs might think that registering as a sole proprietorship might be enough, but there are certain advantages to LLCs. Generally, LLCs offer more flexibility and liability protections, without the complicated procedures and extra costs of other business models.
Another main draw of forming an LLC is that they’re taxed differently from S corporations. The two models are fairly similar in that they protect the owners from double taxation. However, LLCs offer more flexibility, and have less complicated procedures. S corporations are also required to file business tax returns, which are not required for single-owner LLCs.
How Are LLCs Taxed?
As a “pass-through entity,” LLCs have a tax system that sets them apart from corporations. Like sole proprietorships, the profits and losses of an LLC are coursed through business owners or members. These business owners report this information on their personal tax returns, rather than filing for a separate corporation and personal tax.
Single-member
According to the Internal Revenue Service, single-member LLCs are considered “disregarded entities.” This means the LLC’s activities must be filed as part of the owner’s federal tax return.
Single-member LLCs must use the Social Security Number (SSN) or Employer Identification Number (EIN) of the owner for reporting income tax. Generally, these activities will be reported through Form 1040 or 1040-SR.
If the LLC is owned by a married couple in a community property state, and the couple continue to treat the entity as a disregarded entity for federal tax purposes, or as a partnership for federal tax purposes, then the LLC remains as reported. However, in non-community property states, the LLC must file as a partnership. It is important that you make sure to research what kind of rules for joint ownership of an LLC exist in your state.
Multi-member
If the LLC is owned by multiple members, such as a married couple as given in the example above, income tax is generally paid as a partnership. This means that individual partners will pay tax based on their lawful share of ownership in the LLC. This is called a distributive share, and is usually found in proportion to a member’s ownership percentage of the business.
The Balance has a small guide on paying taxes as an LLC. In brief, the partnership will file an information return on Form 1065. Each partner will then receive a Schedule K-1 showing the share of profits or losses in the LLC.
The Schedule K-1 information must then be transferred to Schedule E – Supplemental income. Each type of income, as broken down on your Schedule K-1, will be inputted in specific sections on the Schedule E. You can then include the income as reported in your Schedule E in the relevant sections of your Form 1040 or 1040-SR.
Is an LLC Right for You?
LLCs are favored for their adaptability and relatively simple procedures. However, if your multi-member LLC needs to retain a certain amount of profits, you may find it more beneficial to register as a corporation. In general, however, LLCs are great options for small business owners. Make sure to do extensive research on the tax laws in your state to ensure you’re choosing the right model for your business plan.
