By default, the IRS treats a single-member limited liability company (SMLLC) as a so-called unincorporated entity. This means that the IRS will not treat an SMLLC as a separate entity from the sole proprietor for tax purposes. Instead, just like a sole proprietorship, the IRS will disregard the SMLLC and the owner will pay taxes on the business as part of his or her personal tax return.If you want to know more about the taxation of single-member LLC , all the nuances and pitfalls, read on.
What Is a Single-Member LLC?
When it is the first time you intend to start your own venture, a limited liability company will be an excellent solution. This popular form of business structure offers the owner ample opportunity to customize the enterprise and the advantage of limited liability protection.
The LLC owners are referred to as members. They are unlimited in number, so you are free to open an enterprise on your own or jointly with your partners. According to this principle, all LLCs are divided into single-member and multi-member LLCs.
An SMLLC represents a legal entity formed in the state to carry out commercial activities under its own name, which is not the same as one of its sole proprietors. Normally, an SMLLC has the same legal status as any other LLC.
How Does a Single-Member LLC Work?
Establishing an SMLLC gives the owner a unique set of benefits that other structures don’t have. Among the LLC’s advantages, we can mention the following:
- An LLC delivers limited liability protection, which distinguishes it from a sole proprietorship. This is one of the main reasons why this model is in demand among aspiring entrepreneurs. You also need to follow basic operating principles to ensure that your personal assets are shielded from potential creditors. This includes ensuring that your private and corporate assets are securely segregated. A simple way to achieve this involves using a separate bank account for the needs of the company;
- By officially registering your firm, you will raise its image in the eyes of customers, partners, and investors;
- The LLC name is its exclusive property. The legislation guarantees the owners comprehensive judicial protection of their rights to the company name, so third parties will not be able to use it for their own purposes;
- The creation of such a structure provides access to changing tax treatment. If for any reason, you are not satisfied with “flow-through” taxation, you may apply to the IRS at any time to switch to the corporate tax regime.
Although the LLC registration procedure is legally regulated, it shouldn’t take much time. Moreover, the state fee for it is lower than that for a corporation. In some states, you will also need to draw up an Operating Agreement to determine the company’s management structure and basic working procedures.
Single-Member and C/S-Corp Taxation
As a sole proprietor of an LLC, there are three tax treatment options.
- First, default taxation, in which the IRS doesn’t treat the entity as a separate taxable unit.
- Second, you might apply to switch to the C-corporation tax regime. What is the point of it? Above all, it will allow for more profitable reinvestment in the firm’s reserve funds. Plus, C-corporation owners may also become employees, so you’ll be able to get a percentage of profits in the form of dividends, as well as a paycheck. Employee-owners don’t pay self-employment tax. However, ventures opting for a C-corporation are to file a corporate tax return alongside the owner’s personal tax return.
- Third, if you meet the criteria, you can choose S-corp taxation. Unlike a C-corp, this method lets you take advantage of the “pass-through” taxation benefits. An owner actively running an enterprise is considered an employee, which entitles them to payroll. By changing the ratio of dividends to earnings, you can cut tax costs.
A tax regime change is usually available every 5 years.
How a Single-Member LLC Is Taxed
On-time tax payment constitutes one of the fundamental prerequisites for the stable functioning of any company. The number and type of taxes are determined by state requirements, as well as, of course, by the peculiarities of each organization. Let’s take a brief look at the main types of taxes SMLLCs can deal with.
The owner of an LLC, which is taxed as a sole proprietorship, lists their earnings and expenses, including those derived from the entity, on the Individual Income Tax Form 1040 and Schedule C. Besides, you’ll need to fill out Schedule SE to pay your self-employment tax. Finally, if your firm is related to investments or renting real estate, you’ll also need to prepare Schedule E.
Having quality bookkeeping records is essential for proper tax filing. During the reporting year, keep receipts and records of transactions made by the venture to make it easier to prepare your returns.
Most states support the concept of “pass-through” LLC taxation. In some of them, however, you will have to pay additional taxes. For example, “privilege tax” or “franchise tax,” which are imposed as a fixed amount or calculated according to the company’s revenue. Another common practice is Sales and Use tax, which is compulsory for enterprises selling goods or supplying services.
It is an acronym for the Federal Insurance Contributions Act. This category includes Social Security tax and Medicare tax, which are paid by employers on their own and their employees’ behalf.
When your company grows, you may find it difficult to handle everything on your own. This applies to both bookkeeping and daily tasks to keep the firm running efficiently. As such, LLC owners often hire employees to streamline the operation of the enterprise. They are not the owners of the firm, so it won’t affect the SMLLC’s status.
If you have hired or plan to do this in the near future, the IRS will expect you to withhold income tax on their wages.
They are provided at both the federal (FUTA) and state (SUTA) levels.
The SUTA rate is state-specific. As for FUTA, it is 6% of the first $7,000 paid to an employee. However, if you pay the tax on time, the rate will be reduced to 0.6%.
Please note that an Employer Identification Number (EIN) is usually needed to manage and pay taxes. This is a special 9-digit code that the IRS assigns to a specific organization to identify it. Of course, the SMLLC owners can use their Social Security number (SSN) instead of the EIN, but that option has some drawbacks. Experts recommend not to ignore getting this code, even if it is not required by law. Furthermore, the IRS provides it absolutely free of charge.