Knowing how LLCs are tax should not be foreign to business people. There are many general aspects of LLCs and its structure including taxation that may differ depending on several factors such as election as an S Corporation. Navigate this guide to understand everything regarding LLC taxation whether it’s new to you or you simply need revision.
What is an LLC?
A Limited Liability Company, commonly known as LLC is among the appropriate structures of carrying out businesses. It derives the advantages of both corporation and a partnership, The liability of members is limited like corporations and partnership profits and losses are share like partnerships. This type of business structure lets the owners limit their legal responsibility or exposure to lawsuits besides affording the structure the ability to decide how it is manage and how it is tax.
How Are LLCs Taxed?
The taxation system for LLCs depends on its selected type. Looking at the classifications made by the IRS, an LLC isn’t consider to be a classification of taxation. However, LLCs can file tax returns and be tax as, the following; In this respect, they can file tax returns as the following:
On the other hand, such partnerships as LLCs are tax as sole trader businesses.
Any LLC that has only one member is taxable like a sole trader. An LLC files taxes as a pass-through entity, so the income, expenses, and profits are reflect on the owner’s individual tax return. This is an automatic classification for LLC that has only one member.
Taxing of LLC as a Partnership Company
In the case of the multi-member LLCs, the IRS treat them as partnerships. Company profits are allocate among members, and each of the LLC’s members includes their portion on his or her tax return. For federal income taxes, the LLC does not pay taxes on its own, hence is refer to as a pass-through entity.
LLC Taxed as an Corporation
Some important facts that one should know about LLCs are the following: LLCs can file for corporate taxation. This type of election has the option of being called the “C Corporation” election. This is true because the LLC pays taxes at the corporate level. Those profits issued to owners in the form of dividends are then subject to taxation on personal tax returns.
FAQs of LLC Taxed as an S Corporation
An LLC can also make a subjection to be tax as an S Corporation. In the economic perspective, this election enables the LLC to escape from the double taxation menace. Rather than corporate income taxes, the LLC’s earnings go to the owners, and they report them on their income tax returns.
Advantages Of LLC S Corporation Conversion
There are several reasons for this decision, of electing the S Corporation status. It is beneficial in that it may lead to savings on self employment taxes for the owners. However, as will be seen, the election also introduces more compliance obligations.
Self-Employment Tax Savings
One of the biggest advantages is the ability to avoid Self Employment Taxes for a business that makes an S Corporation Election. It means that when there are profits in a sole proprietorship or partnership, all of them are charge with self-employment taxes. In case of an S Corporation, those taxes only apply to the salaries that are paid to owners.
Pass-Through Taxation
S Corporations take advantage of the fact that they are tax using pass-through taxation. In fact, the LLC does not pay federal income taxes itself. However, in this type of organization, profits are distribute to the owners, and only they are require to pay taxes on such an amount base on their tax bracket. This structure becomes beneficial to assist in preventing the problem of Double taxation encountered by C Corporations.
Reasonable Compensation
However, for a business to qualify as an S Corporation, the owners must pay themselves reasonable salaries. One exception which is required by the IRS is paying a reasonable wage for the work of the owner. This salary unfortunately, is taxable as a self-employed income.
How to file Taxes for LLC S Corp
The procedure of filing taxes for an LLC that is taxed as an S Corporation can be describe as the following. S Corporation status is attain through filing of form 2553 with the IRS on a fiscal basis. This form should be file before the expiry of two months and 15 days of the start of the tax year.
After the election, you are require to complete Form 1120-S, the S Corporation tax return. This form files the LLC’s income, deductions, and credits. Also, you are require to prepare and distribute a K-1 form to each owner of the LLC regarding the amount of income he is subject to.
LLC, S Corp or Sole Proprietorship: Which of Them Is the Better?:
It is therefore essential to consider which form of business structure, LLC tax as S Corporation or the sole proprietor business structure, fits best in the needs of your business. Each structure has its own advantages as well as the disadvantages.
Pros of Sole Proprietorship
Easy to install and quite easy to manage as well.
Hence, there is no requirement of a separate tax return for the business.
No payroll requirements.
Cons of Sole Proprietorship
Any income that you make is incur with self-employ taxes as long as it is profits that you gain.
The only drawback to this category of insurance is that no protection is offered for personal assets in case of an accident.
Benefits of LLC S Corporation
There is a possibility to save some money with self employment taxes.
Resembling the ones given to limit potential liabilities from affecting one’s belongings.
Pass-through taxation shall be free of the double taxation problem.
Disadvantages of LLC S Corporation
It is also more complicate, in terms of establishment and sustenance as well.
Payroll and reasonable salary for owners/ managers/ stakeholders.
Additional tax filing requirements.
How to Elect S Corporation Status For Your LLC
To make this decision to elect S Corporation status for your LLC is very simple. To avoid problems with the IRS, make sure to follow these steps.
Step 1: Filing of Form 2553
The first process that needs to be follow with the intention of getting the S Corporation status is Form 2553 submission. You have to file this form earliest at the beginning of the tax year, that is, within two months and 15 days of the start of the tax year.
Step 2
Here, thus, this is the second step and involves selection of an appropriate tax year.
Another important thing to note when filing Form 2553 is that the applicant has to choose the tax year. The default is the calendar year, but you can use a fiscal year if you get the permission of the Internal Revenue Service.
Step 3: Submit Form 1120-S
After you make the choice to be an S Corporation, you will have to complete Form 1120-S to the extent of each year. This form gives information on the income of the LLC, the amount allow as deductions, and the amount of credits they deserve. There are penalties for failure to file this form as and when due.
Step 4: Disseminate Schedule K-1
After you have file Form 1120-S, you are require to deliver Schedule K-1 to the various owners of the S corporation. This document gives the proportion of each owner of the LLC’s income. These owners use it to prepare their tax returns.
Stakeholder: Management of an S Corporation and How to Maintain Compliance
How to remain in compliance when functioning as an S Corporation requires some ongoing chores. To maintain the S Corporation status, however, you are suppose to obey the IRS regulations and guidelines.
Reasonable Compensation Requirement
They include a fair return for owners, which is one of the most fundamental expectations of stakeholders, as pointed out by www. This salary has to remain related to the work deliver to the business. If the payments made do not meet certain reasonableness criteria, then the employer can face problems with the IRS and may incur penalties.
Payroll Taxes
S Corporation which is a legal entity that functions like any other corporation requires you to withhold and pay Payroll Taxes on any wages paid to owners. This includes; social security tax, Medicare tax, and unemployment tax.
Record-Keeping
Pertinent records must always be kept in order to be certain that all the guidelines are still being observed. One must maintain his records of income and expenses, payroll records and other tax records.
Annual Meetings and Minutes
While not mandate in all states, shareholders’ meetings and keeping of records on meetings held in a year are commendable. Such records can be useful in proving the fact that your LLC is a lawful business entity.
An LLC provides its owners with flexibility when it comes to taxes and there are generally three tax structures to consider for your LLC:
The particular method of taxation that should be used for LLC’s depends on the particularity of the business. Here are the following factors to be taken into consideration.
Business Size and Profit
Think about the size of the business as well as its revenues. If yours is a small LLC firm which is not very popular and generates very little revenue, then setting up a sole proprietor business may be appropriate for you. But if the business is growing, the company could enjoy the tax saving advantage that an S Corporation has to offer.
Compliance Requirements
Consider how you do in managing more requirements that come with the compliance standards. It is time-consuming and needs plenty of paperwork and record keeping to opt for S Corporation status. If you are willing to do these tasks yourself, then the tax benefits may well be attractive enough.
Long-Term Goals
You would want to work with a company that would have a strategy that aligns with your long-term business plans. If you are looking at an expansion of your business and bringing in more partners, then an S Corporation form of business could be of much advantage to you. First and foremost, it gives more flexibility and less legal responsibility as the company grows.
Conclusion
It is thus important to grasp the taxation of LLCs for one to be able to make prudent decisions regarding the business. Both, sole proprietorship and S Corporation have their advantages and disadvantages no matter the kind of business an individual is in. Always take time and evaluate your business requirement and objectives alongside the level of difficulty involved in implementing each choice that is available. This article’s ultimate goal is to help you find the best way to structure your taxes so that your LLC can grow big while minimizing the taxes you are going to be paying.