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Single Member LLC

The following article is a brief overview of single member LLCs, how you form one, various tax issues, and asset protection information specific to SMLLCs. After each section, there will be links (with more added over time) to additional in-depth information on each sub-topic.

Feel free to ask questions in the comment section. Note that this website does NOT give personalized legal advice, I’m not your lawyer, and so you should not post any private information.

What is a Single Member LLC and How Do I Form One?

Quite simply, a single member llc (also called SMLLC for ease of use) is a limited liability company with a single member. Every state currently permits LLCs to be formed with only a single member.

There is no special form used to create an SMLLC. You simply file Articles of Organization and create an entity with only a single member. Some states require that all initial members of an LLC are listed on a document filed with the state when the LLC is formed, others do not. In the case of the SMLLC, then the sole member will be disclosed to the state.

The level of disclosure required by members of an LLC is determined by state law. For example, most states require the LLC to file annual reports listing all the members (and pay a filing fee), while other states require no annual filings.

There are a few states that require SMLLCs to have written operating agreements even when they don’t require multi-member LLCs to do so.

NOTE: The following is a VERY general overview of taxation of single member LLCs. Your particular tax situation will require, of course, more in-depth information. At the very least, you should use reliable small business accounting software and learn how to properly enter your data into it. This will give you solid information for you and and your accountant and/or tax advisor to work from.

The purpose of the information below is to give you an overview so you at least know the landscape and can ask intelligent questions.

Federal Income Tax and the SMLLC

When an SMLLC has not elected to be taxed as a corporation, the IRS “disregards” the LLC as a separate taxable entity. Instead, the IRS treats the single member as the taxpayer.

Note: disregarded tax status is NOT the same as “veil piercing”, when an LLC is found by a court to be fraudulent, and the members held personally liable for the LLC’s debts. It’s a much different concept. Some people read “disregarded tax status” and thinks that means that they will be personally liable for the LLC’s debts.

Any profit earned by the LLC will be treated as income to the single member taxpayer and reported on that taxpayer’s regular 1040, under Schedule C.

Any losses will similarly “flow-through” to the taxpayer–and like profits, recorded on Schedule C–and can be used to offset other income earned by the taxpayer. This can come in handy for SMLLC’s started as “side businesses”, when the taxpayer has a day job with taxable salary, and starts a business in addition. The losses from the LLC can offset the taxpayer’s salaried income. In a later article, I will go into more depth of the limits of this deduction and rules for how it is applied.

Very generally, the LLC’s profit/loss is calculated by subtracting the LLC’s business expenses from the LLC’s business revenue. Again, very generally, a business expense is one that is “ordinary” and “necessary” to the business.
Ordinary means that it is of a magnitude and quality that a reasonable business would use. So, if you have a home-based courier business, and decide to lease a Ferrari and deduct the payments, that’s not “ordinary”, as reasonable courier businesses don’t use Ferraris.

Necessary means that the expense is something that is needed for the business to operate. The term sounds more restrictive than it is as applied. Necessary doesn’t mean that the business will fall apart if the expense isn’t incurred–or as the IRS says, “an expense does not have to be indispensable to be considered necessary”. Rather, it means that the expense of the kind that “helpful and appropriate” for your business.

This IRS page is the reference for the above statements: http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Deducting-Business-Expenses

Self Employment Income Tax and the SMLLC

When the sole member of a disregarded SMLLC records profit and loss on his/her Schedule C, some might ask whether self-employment taxes are due. Self-employment taxes are commonly known as “payroll taxes”, except that as a self-employed person, you pay both the employee and employer share.

These are also known as FICA (Social Security) and Medicare taxes.

Some forms of income are subject to payroll/self-employment taxes, and others are not. This is called “characterization” of income. Some forms of income are subject to payroll taxes, others are not. Currently, interest income, capital gains, dividends, rental income are all not subject to self-employment tax (though the new Obamacare regulations have added a special Medicare tax for some of these forms of income).

With a disregarded SMLLC, however the income was characterized within the LLC, that is how the income will be characterized on your 1040. For example, if the SMLLC owns a piece of commercial property that is being rented, then the net rental income will flow through to the sole member’s Schedule C. That income will not be subject to self-employment tax because it is characterized as rental income, not as “self-employment” income, even if the owner colloquially refers to him/herself as being a “self-employed” in the commercial property business.

The profit from an operating business is generally considered self-employment income UNLESS you can prove that the SMLLC’s income is not subject to self-employment taxes (interest, dividends, rent, and so forth).

SMLLC Member Does Not Withhold Taxes from Profit Distributions

The sole member of an SMLLC is not an employee of the LLC and therefore is not required to withhold taxes from draws of LLC profits or guaranteed payments. As the sole member of an LLC, you should not pay yourself as a W-2 employee.

However, all taxpayers are subject to the requirement of making quarterly estimated tax payments. Taxpayers that receive a W-2 salary have their employer withhold taxes from each paycheck and report and pay quarterly estimated taxes for them. Many taxpayers whose only income are wages subject to withholding don’t realize they have been paying quarterly estimated taxes for as long as they have been working. Well, until they earn income where taxes were NOT withheld…then they get a big tax bill in April of the following year and might get hit for penalty/interest for underpaid quarterly estimated taxes.

As the sole member of your LLC, you are responsible for quarterly estimated tax payments on the amount of profit your LLC will earn this year.

Some of you are thinking “but I have no idea how much profit I’ll make this year–this is unfair”. To ease this concern, the IRS has certain “safe harbor” rules for quarterly estimated taxes. This safe harbor is based on last year’s income tax. Quality small business accounting software and personal tax software will help you greatly in compliance.

Deduction of Personal Funds Used For Unreimbursed LLC’s Business Expenses

When an employee expenses personal funds for business expenses of his/her employer, and is not reimbursed by the employer, the employee is allowed to deduct those on Schedule A as “Unreimbursed Employee Expenses”. See http://www.irs.gov/publications/p529/ar02.html.

Unfortunately, these deductions have a 2% of AGI floor on them. Meaning that if your AGI is $40,000/yr, only the amount above 2% of $40,000 — $800 — is deductible. The first $800–the “floor”–is not deductible.

However, as the sole member of an SMLLC, you are not an employee. Therefore, all ordinary and necessary business expenses are fully deductible regardless of out of whose funds they are paid.

While this is helpful, do not get into the habit of mixing personal and business funds. For one, it might make your business look more like a non-deductible hobby…especially in the early years if your business is losing money. Secondly, mixing personal and business funds–called “co-mingling”–can put your LLC’s limited liability at risk. Finally, it complicates accounting.

Therefore, you should open a separate business account, seed it with a loan or capital from the member or a lender, and deposit all business revenue in that account and pay all business expenses from that account. Use quality small business accounting software to track all transactions and your life will be much easier at tax time.

Worker’s Compensation and Unemployment Insurance Not Required for Sole LLC Member

A member of a SMLLC is not required to be covered by worker’s compensation by the LLC, because that member is not an employee. If your SMLLC has other employees, of course, they must be covered per state law.

Furthermore, the LLC is not required to pay Federal Unemployment Tax –currently 6.2% of the first $7,000 in wages–for the sole member. As above, if the LLC has employees (not counting the sole member), then the LLC must pay FUTA tax for those employees.

Piercing the Corporate Veil

There are a few practical and important differences between a more traditional, multi-member LLC and single member LLC. The most
significant example is the belief among some attorneys that single member LLCs are more vulnerable to “having their veil pierced” than LLCs with
multiple members.

Veil-piercing, if you are unfamiliar with the concept, is one of the worst things that can happen to a business entity such as an LLC or other
corporation. The term refers to what happens when, in a court of law, a business’s status as a separate entity [and the limited liability protection it provides for its owner(s)] is ignored. The court rejects the notion that the business is clearly separate from its owner(s), and instead the owner(s) is held personally liable for business debts. These “debts” can be anything the business owes, from legal judgments to loans.

$50,000 in Veil Piercing Insurance – Free

To give you added protection against being held personally liable for your business debts, the Company Corporation offers a $50,000 Veil Piercing Guarantee free with all LLCs formed through them. Read a full review of the Company Corporation, or form your LLC now.

Having your corporate veil pierced can be a devastating event for both you and your business. Epic problems that were once confined to your
work life can infiltrate your personal life and have a huge impact.
While operating as a single member LLC is not alone sufficient cause for a court to disregard your business as a separate entity, there is anecdotal evidence that single member LLCs are more likely than multi-member corporations to have their veil pierced by creditor claims.

Filing Taxes For Your Single Member LLC

TurboTax Online now offers a service for filing the tax returns of single member limited liability company owners.
It’s called TurboTax Online Home & Business. As of 2012, pricing starts at $49.95 for federal returns. State returns are additional.

Efile is included for free as is their service which helps you identify over 350 business expense deductions you’ve probably overlooked.
TurboTax’s interactive question and answer format guides you through the tax return and helps you identify potential deductions.
Instead of trying to memorize J.K. Lasser’s tax encyclopedia (which is a good resource), Turbotax asks you simple questions like “Did you sell a home during 2012?” and tailors its followup questions based on your answers.

Get started with Turbotax Home & Business for your single member LLC here.

Note: If you have a multi-member limited liability company, you will want to use Turbotax Business, found here.

Other Articles of Interest

Find out if your state allows single member LLCs

Visit LLC Made Easy’s state by state listing of LLC requirements, including filing fees.

Double Taxation

Learn about the C corporation’s double tax and how to avoid it with an LLC.

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Reducing Your LLC’s Taxes

Reducing taxes and limiting personal liability are the two primary reasons for forming an LLC.

While incorporating cannot eliminate taxes (unless you make no money!), choosing the right entity can have a dramatic impact on the amount of tax you pay.

Know Your Entity

Choosing the right entity for your business can have huge tax implications. Even worse, switching entities after you’re business has started can cause huge tax headaches. The LLC has the great advantage of being “tax” neutral when changing corporate forms. Learn about the difference corporate forms and their tax implications before you commit.

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Learn the important differences between the S-corporation and the LLC, particularly the limitations of S-corps on the number of shareholders.

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Why You Pay Too Much In Taxes

There is no duty for a citizen to pay more in tax than their minimum legal obligation.

Are you using every deduction you’re entitled to?

Do you even know which deductions you’re entitled to?

Do you have a system for tracking your deductions and keeping your receipts?

If you answered “no” to any of the above questions, you could be overpaying taxes by thousands.

Unrecorded deductions are the main reason for small businesses paying too much tax. Learn how to get your accounting in order and maximize your deductions.

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Have Your LLC Tax Questions Answered.

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Because your question will be published on its own page, please don’t give your full name, phone number, etc.

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My LLC Never Made A Dime, Do We Have To File Taxes?

We have a Florida LLC that is over a year old and has never made any money. Do we need to file tax statements for the year or pay penalties for not having already done so?

Answer

An LLC is required to file taxes each year, even if it lost money and it’s beneficial to you because, under the tax laws, you can carry losses both forward and backward.

Example: If your LLC made money in 2005 and paid taxes, and then lost money in 2006, you can apply your 2006 losses to your 2005 tax return and receive a refund.

In order to carry-back your losses, you need to file a turn return, however.

For LLCs taxed as partnerships or disregarded entities, it’s also important to file your returns even in years where you lost money for similar reasons.

LLCs with pass-through taxation let you take your LLC losses (subject to certain limits) on your individual tax return. By failing to report your LLCs losses, you end up overpaying your personal taxes.

The bottom line is that you should file tax returns for every year in which your entity existed, even if it made a loss.


Return to Ask A Question About LLC Taxes.


Do I have to file personal income from paychecks made from own LLC?

by yan
(los angeles)

I have an LLC, if I make myself a pay check every month, do i have to file personal income? meaning that I’d have to file taxes for the LLC, and personal ones separately?

Answer

If you have chosen to treat your LLC as having “pass-through” taxation (that is, taxed like a partnership), you only pay taxes once.

However, you do file what’s called an informational tax return for your LLC (Form 1065). The LLC then issues each member a form K-1, which tells the member how much income they need to report on their personal tax return.

If you run a single member LLC, your LLC can get disregarded entity status, which means you don’t even file a form 1065–you simply include your LLC’s revenues and expenses on Schedule C of your personal 1040. The same goes if the only members of the LLC are husband and wife filing a joint tax return.

Question About Reporting LLC Income

Question: If I have LLC and put my earned income in LLC account, with an tax ID (not my SS #), can any one know that is my income? — By Anonymous

Answer:

What do you mean by “anyone”?

The IRS will know, because your SSN (or someone else’s associated with your LLC) was used to apply for your LLC’s EIN.

The IRS will also know based on any 1099s it receives from businesses that send payments to your LLC.

Does your business accept credit cards? Under new IRS regulations, your credit card merchant account processor will begin reporting all your merchant account transactions via a 1099-k. Therefore, the IRS will know how much income your business received in credit card payments received.

Can casual creditors know? Probably not, particularly if you used an outside service as your registered agent and not your own home or business address.

Persistent creditors can find out by subpoenaing you to a judgment debtor examination and other legal processes.

I know you didn’t quite go that far, but for the future: please don’t ask me how to evade taxes. Any questions like that will be deleted as spam.


Return to Ask A Question About LLC Taxes.


Tax Help Reimbursements / Deductions with LLC

I have a business bank account. All of my payments from the website go directly the LLC bank account. I have done some research and I’ve been reading that the worst thing to do is to take money out of the LLC bank account and deposit it into your personal bank account because of hefty taxing.

I have also read that what should be done is leave the money in the LLC account and use the money from that account to pay for expenses that the LLC can reimburse for like, cell phone, internet services, gas, my car, dining, business travel, computer equipment etc.

3 Questions:

1) Is this true?
2) I know taxes are inevitable, but what is the best way to minimize tax from the LLC?
3) What exactly can I reimburse and what percent of it can I reimburse?

Answer

What you read is partially correct and partially wrong.

If your LLC is taxed as a partnership, then all profits flow through to you personally and are reported on your personal income tax statement.

This is true regardless of whether you leave the profits in your business account or not. (Note, if you are taxed as a corporation, a whole new complexity arises with regards to leaving money in the corporation, which really requires a tax attorney to sort out).

What you read is correct in that you can minimize taxes by having your LLC pay all your business expenses.

This is where you must make best use of being the owner of a small business–by taking every legitimate deduction you can.

You should absolutely pay all your business expenses out of your LLC’s business checking account.

I assume from your question that you run a website. So legitimate business expenses would include hosting fees, software purchases, your internet connection, any computer hardware you use exclusively for your business (e.g your laptop), etc.

Here’s a 30,000 ft overview of how your LLC taxes will be computed:

At the end of the year, you add up all your revenues from your LLC–adsense income, income from sales of products, affiliate income, and so on. That is your revenue.

Then you add up all your business expenses: phone, internet, hosting fees, money spent on advertising, etc. That is your expense.

Subtrac expenses from revenue and you have your business profit or business income.

It is on this business income that you pay taxes.

As a single-member LLC, these calculations of business revenue and business expenses will all be done on Schedule C of your 1040.

If you do the math, it’s clear there are only two ways to cut your taxes:

1. Make less money
2. Increase your business deductions

No one wants to do option 1., so option 2 is where you can save a ton of money.

The few deductions you and I mentioned are only a fraction of all the deductions that a small business owner can take. There are many others as well.

I recommend that you get a copy of Wayne Davie’s Tax Reduction Toolkit. It contains 29 small business tax deductions that you’ve probably never heard of, plus instruction and guidance on how to backup those deductions when dealing with the IRS.

I also take it from your question that you are concerned that the deductibility of an expense depends on whether you wrote the check for the expense out of your business or personal bank account.

You technically can pay business expenses from your personal account and take a deduction, but that is a bad habit to get into. By doing so, you are commingling personal and business assets and risking have your corporate veil pierced. In addition, you might have a tougher time in an audit justifying your home phone bill as a business expense if you paid for it with a personal check.

Expenses that are part personal and part business

Question: As a single member LLC considered a pass through entity by the IRS I deduct part of my mortgage and utilities on my taxes. I also have a cell phone and additional landline that are for business but they are in my personal name as they were set up before the LLC was created, when I was a sole proprietor. Is it best to pay for these expenses from my personal or business bank accounts? I would think that paying mortgage and electric, etc. from a personal account and taking a deduction is not seen as co-mingling funds but how about the landline and cell phone that are in my personal name but used for business.
Thanks.

– by Jay, MD

Answer

The simplest answer is to open up a cell phone plan for your business and use that exclusively for your business conversations.

Otherwise, technically, to take a business deduction for your phone calls when the line is in your personal name, you’re going to have itemize your phone bill and show which calls were personal, which were business, and determine the percentage of the bill that were business.

By the time you go through all that, you’re ready to just pay the darn tax and be done with it!

The other method is to itemize your business expenses that you paid for personally, submit a reimbursement form to the business, and have the business write you a check.

This is how you would seek reimbursement from a company you were an employee or contractor for. A member of an LLC can use the same method for his own reimbursement of business expenses paid for with personal funds.

As a general matter, have the business directly pay for as many business expenses as possible.


Return to Ask A Question About LLC Taxes.


How To Avoid Double Taxation With An LLC

Owners of new businesses choose to form LLCs for two primary reasons. The first of these is to turn their business into its own entity that exists as a separate thing from their person. By doing so, they limit their personal liability for their business debt.

Conversely, owners who choose not to form an LLC and operate as a sole proprietorship or as an unincorporated partnership accept the risk of being held personally responsible for all of their business debts – including lawsuits. This means that a business creditor, as well as someone who has won a lawsuit against your business, may come after you personally for payment. This means that your home, car or personal savings could be taken away.

A traditional form of incorporation can accomplish the same goal of limiting personal liability, however forming an LLC can offer even better protection by helping you to avoid double taxation.

When a corporation earns a profit, it is taxed at a special corporate rate. The corporate rate is similar, but not identical, to personal income tax rates.

Before the owner of a corporation can spend the corporation’s leftover profits, they must receive them into their personal accounts as dividends. Once the owner receives these profits, the money will be taxed again in the form of a personal income tax. In this way, taxes are collected from one pool of money two times (first as a corporate tax, and then as a personal income tax on dividends) hence the term “double taxation”.

An owner, or “member”, of a business that is formed as an LLC can completely avoid double taxation by choosing to organize as a pass-through entity.

By doing so, the owner will only pay for taxes once, in the form of a personal income tax. The IRS and state laws have made designating pass-through taxation relatively easy by providing a selection box on your state’s Articles of Organization form.