Do you own a limited liability company (LLC) and need to know how your income from the business will be taxed? Read on to find out.
A limited liability company is the chameleon of business entities. Believe it or not, there is no LLC-specific federal income tax return. But that does not mean your business profit is exempt from federal income taxes.
A LLC can choose how it wants to be taxed. If you are the only owner (or "member") of the LLC, your business can be taxed as a sole proprietorship, a C corporation, or an S corporation. If your LLC has two or more owners, it can be taxed like a partnership, a C Corporation, or an S corporation.
So it's up to you. This may come as a surprise to you, but you really do get to choose how the IRS will tax your income.
Having said that, keep in mind that if your business is a single-owner LLC and it does not choose to be taxed as a corporation, then you are automatically treated as a sole proprietorship for tax purposes. And if your business is a multi-owner LLC and it does not choose to be taxed as a corporation, then you are automatically taxed as a partnership.
In effect, by not choosing to be a corporation, you are choosing to be taxed as a sole proprietor or a partner. And if you go that route, keep in mind that your business income will be subject to both income tax as well as self-employment tax.
Now that you realize that you get to choose how your income will be taxed, how do you go about making that decision? Here are three suggestions in that regard:
1. Do not assume that the sole proprietorship or the partnership is the best choice of entity for your business. If you do nothing, you are letting the IRS decide how you will be taxed. Does that sound like a good idea? It may be that the default tax classification is the best one for you, but do yourself a favor and do some research to find out for sure. There are many good resources available on the topic, from books to websites to competent tax professionals who specialize in small business tax issues such as choice of entity.
2. What is good for someone else may not be good for you. Just because your brother-in-law has a C corporation doesn't necessarily mean that you should have one, too. When it comes to choice of entity, ignore any advice that advocates a "one size fits all" approach. Everyone's tax situation is different.
3. The tax consequences of each entity can be significantly different, so do not delay getting some help to make this all-important decision. Thousands of dollars in tax savings could be at stake.
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