When starting a new business, one of the first legally binding decisions you'll have to make is what business structure to use. Many new entrepreneurs choose to form an LLC, or Limited Liability Company, for the protections and simplicity it offers. But before choosing one, it's important to understand the tax implications and responsibilities of an LLC.
By default, LLCs are treated either as a sole proprietorship or partnership depending on how many members there are in the company. As such, the LLC itself does not pay income taxes; rather, it passes through the income to each of its members who pay taxes on their portion.
For a single-member LLC, you will report the company's earnings and expenses on Schedule C. Attach Schedule C to your Form 1040. Multiple-member LLCs distribute the profit and losses among the members in a way that was decided when you created your LLC operating agreement. Each member must receive a Form K-1 from the business, showing their portion of the earnings. They will then report this on Schedule E and attach it to their personal income taxes.
This "pass through" taxation has its ups and downs. It's simpler than filing corporate taxes and will be less expensive when hiring a tax preparer. It also avoids "double taxation," where both the corporation and its shareholders pay on the same profits. But if you are a member with limited personal liability, you may not be able to claim all available losses. And if your personal income tax rate is high, you may end up paying more overall income taxes.
Just like any other business operating in a jurisdiction, your LLC will be required to pay appropriate sales taxes. Sales taxes are generally reported and paid to state governments on a monthly, quarterly or annual basis depending on the size of your tax liability. Some cities or counties may also collect sales tax (even if your state doesn't do so), so you should talk to your accountant to ensure you understand all the tax liabilities in your area and how to report them. The good news is that you may find that your state offers a streamlined system in which you only have to pay the state and it doles out appropriate money to other entities.
LLC owners, or "members," are not by default employees, so you are not subject to paying FICA, Medicare or withholding on your own earnings. This will simplify your accounting. Each member of the LLC will instead pay these taxes as part of their own personal income taxes. Income taxes are charged and reported as outlined above, while FICA and Medicare are paid as part of the Self Employment Tax (SE Tax) figured on each member's personal Form 1040.
However, if you hire regular employees, your LLC will have to pay employment taxes just like any other business. Before deciding to hire workers, then, it's a good idea to discuss the new liabilities with your accountant.
Figuring out the right business structure for your new venture can be complicated. Since the tax implications -- good, bad or neutral -- are an important part of the puzzle, it may be best to consult with a qualified accountant before making any decisions. Knowing what you're getting into will help you avoid surprises and ensure a profitable business for years to come.
For tax preparation, contact a company such as HBE Becker Meyer Love LLP.