Quite possibly, the most common business structure is the limited liability company or LLC. Business owners love the flexibility, low cost, and ease of setup an LLC offers. Additionally, with many service providers available to set up an LLC, it is no surprise that many business people consider the first type of business structure is an LLC. And in turn, the most common way of starting an LLC is through sole ownership. In this scenario, we call the structure a single-member LLC (SMLLC).
An LLC is a business structure that exists at the state level. When organizing an LLC with the secretary of state, you do so by registering it in a given state, such as Delaware, California, Wyoming, and so forth. Owners of an LLC are called members, and there is tremendous flexibility in that members may include individuals or even corporations.
What’s The Default Tax Treatment For A Single-Member LLC (SMLLC)?
According to IRS rules, an SMLLC is disregarded for U.S. income tax purposes in terms of the default tax treatment of a limited liability company.
What does this mean? This means all the income and expenses of the LLC flow through to one’s personal tax return on Schedule C of Form 1040. It also means that no separate federal tax return is needed for the LLC and that the income from the LLC is considered self-employment income, on which the taxpayer will pay federal income and self-employment tax (such as social security and Medicare).
Disregarded Entities and Federal Taxes
When an entity is disregarded, given that the business income and expenses, and hence, profit, flow through to the individual’s tax return (on Schedule C of Form 1040), the taxpayer is liable for federal income tax on the profits of the entity. However, self-employment tax is also payable on the profits of the business (and reported on Schedule SE of Form 1040).
To change the tax treatment of your LLC, you need to file a Form 8832 to change the default classification of the LLC for tax purposes. This election needs to be made within a year before it becomes effective, or within 75 days after it becomes effective. This means that with a new entity, Form 8832 needs to be filed within 75 days of the start of the entity’s fiscal year. To learn more, visit our blog on Check the Box Elections. There are scenarios, however, where you may be able to make a late election. For guidance on this matter, please get in touch today to discuss your options if you are operating an LLC and wish to change its default classification on a delinquent basis.
You Must Pay Tax On All Profit (Whether You Distribute It Or Not)
It is important to note that even if you do not distribute any of the LLC’s profit, given that the LLC is a pass-through entity, you will need to report and pay taxes on all profits of the LLC. This is the case even if you leave the profits in the bank and do not use the funds for any purpose.
Paying Business Tax As A Single Member LLC
While operating an SMLLC is simpler than running a large corporation, there are still many obligations to fulfill, particularly as it concerns paying business taxes. Below you will find details on the various business taxes you may have to pay when operating your business in this way.
Filing As A Sole Proprietorship
When you treat an SMLLC in its default manner, as a sole proprietorship, you are liable for tax on the profits generated by the business entity, which, as we discussed, are reported on Schedules C and SE of Form 1040. Additionally, depending on the state the LLC is organized in, you may also have to file a separate form for the LLC (such as Form 568 in California) and pay a franchise tax and/or a minimum LLC tax. Further, you may also have to pay an annual fee to a registered agent for receiving mail or legal documents on your LLC’s behalf.
Filing As A C Corporation
If you decide to elect for your LLC to be taxed as a C Corporation for tax purposes, you will need to report the income and activities of the LLC on a corporation tax return on Form 1120. The federal tax rate for corporations is currently 21%, and state income tax rates (and required forms) vary.
Filing As An S Corporation
When filing as an S Corporation, you would need to file a separate tax return for the LLC (Form 1120S), but the profits ultimately flow through to you, the individual (on Schedule E of Form 1040). Therefore, the treatment is similar to that which we discussed in the first scenario above.
How A Single-Member LLC Is Taxed
As mentioned previously, the default treatment is as a disregarded entity, where all income and expenses (and hence, profit) flow through to the individual’s personal federal tax return. However, if you elected for the LLC to be taxed as a C Corporation, the tax treatment will differ. Further, if you elected for the LLC to be taxed as an S Corporation, then the tax treatment would be as a disregarded entity.
Employment Tax And Certain Excise Tax Requirements
Just because one’s business is structured as an SMLLC does not mean that that sole proprietor does everything. Indeed, you might be operating a business as a sole proprietorship but also have employees. In this scenario, ensuring that you are complying with your employment tax obligations (such as payroll, making federal and state tax withholding payments, and so forth) for your employees is critical. Additionally, depending on the type of business and industry you are in, your LLC may also have excise tax obligations (business taxes imposed on various goods, services, and activities). If you are unsure whether your small business may have excise or employment tax obligations, please get in touch today to ensure that you are running your business in a manner that complies with employment and excise tax requirements.
Bookkeeping And Accounting For Single-Member LLCs
It is crucial to get the bookkeeping and accounting correct for your small business from the start. Many people erroneously think that just because an LLC has only one member, they can just get started and then handle the bookkeeping later. Nothing could be further from the truth. We must remember that an SMLLC is a business, just as a partnership is a business, a corporation is a business, and so forth. And therefore, it is crucial to take the finances of the LLC very seriously, just as a large corporation such as Microsoft or Walmart would.
If you are considering organizing an LLC or have already organized an LLC and need guidance on the bookkeeping or an operating agreement, please get in touch with us today. Indeed, one of the biggest strengths of an LLC is its flexibility, but that also means there are plenty of areas where things can go wrong. You don’t want to be scrambling at the last minute before the tax filing deadline because the bookkeeping has not been done beforehand.
In addition to the tax implications and obligations of running an SMLLC, there are other things to consider too, which may not be directly related to taxes. Below are a few frequently asked questions (and answers) that you may be curious about.
Can A Married Couple Be A Single-Member LLC?
Yes, you actually can. If you live in one of nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin), and you and your spouse jointly own an LLC, then you can elect to treat the entity as an SMLLC. In this scenario, all the income and profits of the LLC flow through to Schedule C of your joint tax return (Form 1040), and there will be no need to file a partnership tax return (Form 1065).
What Is The Best Way For A Single-Member LLC To File Taxes?
This is a subjective question. As mentioned previously, the default treatment of an SMLLC is that it is a disregarded entity. However, this also leads to a situation in which you are liable for not only federal income tax but also self-employment tax. Thus, you may decide to elect to have the LLC be taxed as a corporation to avoid this situation. However, in this scenario, profits distributed to the LLC owner are taxed, as well as the profits being taxed on a corporate level. Therefore, depending on one’s unique situation, it may or may not be better to go with the default classification of an SMLLC.
What Can You Write Off On Taxes For Single-Member LLC?
When conducting business as a single-member limited liability company, you may deduct all necessary and allowable business expenses incurred as a result of operating the business. Of course, the exact categories depend on the type of company you are running as well as your operations, but common categories of business expenses include advertising, rent, travel, meals (usually deductible only up to a certain percentage), supplies, repairs, legal fees, insurance, and so forth. Please note that the LLC cannot deduct personal expenses and that doing so may land you in big trouble with the IRS.
Are LLC Single Taxed?
Yes. Given that the IRS considers SMLLCs as sole proprietorships for tax purposes, the LLC itself does not pay tax. Rather, the profits of the LLC flow to your individual tax return, and you in turn pay tax on the profits of the LLC on your own personal tax return.
Does A Single-Member LLC Need A Separate Bank Account?
Generally speaking, yes, a single member limited liability company would need its own bank account. But why? Because not only does it simplify things from a bookkeeping and accounting perspective to have different accounts for personal and business, but commingling personal and business funds are risky in a legal sense. Mixing personal and business finances may lead to a situation in which if the limited liability company is sued, it may lose its liability protection (a term referred to as “piercing the corporate veil.”).