What is an LLC?
If you have been in business for a little while or even if you are just starting out, you have probably heard people talking about setting up their LLC. When you see those three letters, do you instantly think, “Do I need one of those? What even is an LLC?”
What is it?
An LLC is a limited liability company that is established to protect the owners/members. It ensures that the owners/members are not personally liable for the debts or liabilities of the company. In short, it protects your personal assets in case someone sues your business or you business fails and you have outstanding debts. The LLC designation is only a state-level designation, in other words, it means nothing to the IRS.
You can set up a single member LLC which is just an LLC with only one member/owner or a multi-member LLC which would include yourself and another person(s). The tax treatment of a single-member LLC and a multi-member LLC are different (keep reading) so make sure you understand the differences before adding someone else to your business, even if it’s just your spouse.
How do i get one?
The exact rules and process for setting up your LLC will vary depending on the state where you live. As a general rule, you should start with your Secretary of State’s office for your state-specific requirements. Most states require the completion of a short registration form, often called the Articles of Incorporation, and the payment of a registration fee (ranging from $30 - $200).
Some states also require the LLC to draft an operating agreement, even if it is not required it is still a good idea, especially for a multi-member LLC. The operating agreement details the business arrangement, ownership percentages, roles, as well as rights and responsibilities. This agreement helps solidify the protection of the owners.
You are not required to hire a lawyer or CPA to set-up your LLC however, if you have any questions or concerns, you should have a lawyer review your registration form and operating agreement.
How does an LLC affect my taxes?
Now on to the good stuff, how does forming an LLC impact my taxes? The tax treatment of an LLC will depend on two factors: the number of owners/members, and any elections made with the IRS.
For an LLC that has only one member, the IRS treats the business as a “disregarded entity,” simply meaning you report all of your business income and expenses on your personal tax return via a Schedule C. If you already had your business up and running prior to forming your LLC, this is how you were previously reporting your income so there is no change. You will be assessed a self-employment tax of 15.3% on the net profit of your business, so income minus expenses times 15.3%. This self-employment tax covers the FICA and Medicare taxes that would typically be taken out of your paycheck if you were working for someone else. The income from the LLC is included on your individual tax return and subject to tax based on the tax bracket you fall into.
For a multi-member LLC, unless elected otherwise, the IRS treats the company as a partnership. The tax impact to the owners/members is similar to the single member LLC except there is an additional step required. The business will have to complete a Form 1065 and issue K-1s to each owner/member which details their respective portion of the company’s profits/losses. Each owner/member then reports the K-1 on their individual tax return . The earnings passed through are subject to self-employment tax just like the single-member LLC (see above) and are also subject to tax based on the bracket you fall into.
An LLC (regardless of the number of owners) can elect to be treated as a corporation by the IRS. With this election the company can be taxed as either a C corporation or S corporation. Both entity types are subject to very specific rules about how they are organized and operated. One of the main points to consider is that an owner of either type of corporation must become an employee of the company and take a paycheck. There is no more moving money from your business account to your personal account and back.
There will likely be a point in your business that you should talk to an attorney or CPA about evaluating whether you should make an election to have your LLC treated as a corporation. It is a very individual decision and will depend on many factors.
Now that I have given you the quick and dirty details about an LLC, how to form one, and how they impact your taxes, I hope you give some serious thought to how your business is structured. If you have any questions about LLCs, even forming one in your state, send me a message, I would be happy to help in any way that I can!