If you’re a current or soon-to-be small business owner in the United States, chances are you’ve heard about or have considered becoming a Limited Liability Company (LLC). It’s the ideal entity structure for small businesses, as it generally has the most straight-forward tax filings, to make your life that much easier.
In this blog, we’ll take a deep dive into the tax considerations of this entity structure.
Understanding LLCs and Other Businesses
Organizing your business as an LLC could be the perfect move if your small business is looking for flexibility and limited liability. After all, in this entity structure, the owner’s liability is limited to a fixed sum, which typically does not exceed the amount invested in the business.
This type of limited liability is also found in other business entities, like single-member LLCs (SMLLCs), partnerships, S Corporations and C Corporations. As such, an LLC can elect to be taxed as any of these other entities.
However, an SMLLC is treated as a disregarded entity for tax purposes. This means that the IRS ‘disregards’ the LLC entity and treats the business like a sole proprietorship.
On the other hand, a multi-member LLC is treated as a partnership for tax purposes. As such, the number of members in your LLC can seriously impact your tax obligations. It’s also why there’s usually no distinction between ‘partners’ and ‘members’ for federal tax purposes.
But what exactly does all of that mean?
SMLLC Taxation
If you have only one member in your LLC, you’ll need to make quarterly estimated tax payments by a specific date for the income you receive throughout the year. You can withhold these taxes (by saving an estimated amount to pay directly to the government), or make estimated payments.
If you’re an individual owners of a single-member LLC, use Schedule C of Form 1040.
Partnership Taxation
As mentioned above, if you have multiple members in your LLC, you’ll be taxed as a partnership. This means the LLC itself does not pay taxes on its income. Instead, your business income, losses, deductions, and credits flow through to you and other members or partners. Then, these are reported on your personal income tax returns. To do so, you’ll make estimated tax payments.
Partnerships share profits and liabilities. But how this is taxed depends on whether you’re an active or passive partner. You can also implement special allocations on your tax returns. these are based on conditions set out in your partnership agreement. For example, one partner might own 25% of the business, while the other owns 75%. This means that profits and losses are allocated according to the percentage owned by each partner.
Choosing the Best Entity Structure
Understanding the tax differences between entities is fundamental to business development. Remember that your entity structure directly impacts your tax obligations. Therefore, you must carefully consider this when you start a business, or when you want to change entity type.
Of course, if you’re in any doubt, or need assistance, it’s best to consult with a tax professional.
Fusion CPA’s team of experts understands the tax implications of each entity and can help you decide on the most suitable entity for your business.
For guidance on business entities or taxation, schedule a Discovery Call with one of our CPAs.
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.
