llc tax liability
Suppose you desire to register your business as a Limited Liability Company (LLC). In that case, it is important to know how you are going to receive an income and how your business’s income will be taxed.
The first thing you need to do is you must understand the type of LLC that you want your business to be categorized as. For all practical purposes, there are two major classifications of an LLC: The default state for LLCs and LLCs as a corporation.
The default state means that you are registered as an LLC but your annual income is taxed as though your company is a sole proprietorship or a partnership.
The other category, registering your company as a corporation, means that your company will be taxed as a single entity, with employee conditions applied.
In this article, we are going to go into the nitty-gritty of this discussion however, our emphasis will be on how you get paid as an LLC in the default state.
The default state for LLCs
LLCs like every other business has an owner or a group of owners. These owners are called members.
For a Limited Liability Company with just one owner, we can refer to the business as a single-member company. As the sole member, the business is not regarded as an entity apart from you. You are regarded as ‘the business’.
When the LLC has more than one member, it is called a multi-member LLC and is taxed like a partnership business would be.
LLC Income
Income and taxes for a single-member LLC
We have seen what a single-member LLC means, now, we will look at how you as the sole member of the LLC can get paid.
As I earlier mentioned, you are considered as the business, not as the employee. So, you do not get a ‘salary’. Instead, you can write yourself a check and withdraw money for yourself from the business’s account. This is called an ‘owner’s draw’.
However, you are taxed as a sole proprietor is taxed. You have to submit a report on the profits and losses and your business is taxed on all its profit for the year on the Internal Revenue System (IRS) Schedule C (as your income) regardless of your ‘draws’. What this means is that you do not need to pay any taxes on whatever you withdraw since they are not regarded as a salary.
You will also be required to pay self-employment taxes which include social security and medicare.
As a single-member company, you can also choose to be taxed as a corporation. If you register the company as a corporation, you will be regarded as an employee and you will be paid a salary. Then, you will no longer need to pay self-employment taxes.
pro forma income statement for a multi-member LLC
For limited liability companies that have more than one member, the business is taxed the same way a partnership is.
Each member of the company has a share in the business and therefore share ownership as well, however, this is to the degree of their investment or to a higher or lower degree depending on the operating agreement. Simply put, the profits or losses are shared by each member.
There are two ways you can get paid as a member of a multi-member LLC: you can pay yourself by taking withdrawals from your shares just like the Single-member LLC’s ‘owner’s draw’. Or the company can set up a guaranteed payment system for each of the members. This works like a salary, it just ensures that each member is paid whether or not the business achieves the desired profits.
Although the company reports its total income to the IRS, taxes are taken from each member’s shares of the profits and not the total income. This is why as it regards taxes the Multi-member LLC is called a ‘pass-through entity’. Each member is also required to pay self-employment taxes as well.
Electing the LLC as a Corporation
Single or multi-member LLCs can request the IRS to have their company to be treated as a corporation.
The LLC can either opt to be an S corporation or a C corporation.
As an S or C corporation, members are regarded as shareholders and are treated as employees meaning that they will be paid a salary instead of taking ‘owner’s draw’. Salaries are can be determined by the members of an LLC but they must be in accordance with the ‘reasonable compensation’ standard as set by the IRS.
Also, both the C and S corporations are separate legal entities. This means that the owners are separate from the business. And the company is the owner of the business.
However, C corporations are taxed on a corporate level. For a multi-member LLC, there is a very great possibility of each member being taxed again if dividends are distributed. This is because dividends are considered personal taxable income. This process where the company is taxed on its income and then each member is taxed on its dividends are referred to as ‘double taxation’.
S corporations on the other hand are taxed as ‘pass-through entities’ which means that the company reports its total income but is taxed at a member level.
There are some benefits to having your LLC as a C or S corporation. For one it is able to ensure tax savings.
Before you choose the type of LLC you want to establish your business as ensure to seek the advice of qualified professionals so that you are well informed of any other types of taxes that may be payable.