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Self Employment (SE) Tax for LLCs

If you’ve received a salary your whole working life, you’ve already been paying Social Security and Medicare taxes…aka self-employment tax.

It’s just that your employer has done the work of calculating, filing, and paying those taxes on your behalf.

Also, your employer paid half of those taxes for you. Of course, your employer set your salary knowing what those taxes would cost it, so you weren’t getting a free lunch as an employee.

As a self-employed business owner, you are the employer and are responsible for calculating and paying your self-employment taxes.

As a small business owner, you’re still required to pay payroll taxes such as FICA (Social Security) and Medicare taxes on your income, only now it’s called Self-Employment tax (SE). Now that you’re self-employed, it’s your job to calculate and report your employment taxes.

How a Single-Member LLC Computes SE (Self-Employment) Tax

As a single-member Limited Liability Company, the IRS treats your LLC for tax purposes as a “disregarded entity”, which is taxed as a sole proprietor for income tax purposes. Don’t worry, all the limited liability aspects of your LLC are intact.

Remember that an LLC where the only members are two married individuals (that is, married to one another!), the LLC can be treated as a single-member LLC and thus have disregarded entity status.

Disregarded entity status means is that you don’t file a separate tax return for your LLC.  The LLC does not pay taxes on the profits and those profits pass through to you personally. As a pass-through entity, you simply report your business income and expenses (all those deductions you’ve been tracking and keeping receipts for) on a Schedule C on your form 1040.  Any remaining profits are considered self-employment income.  Any losses would be considered self-employment deductions.

After completing your Schedule C, you’ll then complete a Schedule SE which will calculate your self-employment tax.

You pay approximately 13% FICA on the first $100,000 of your LLC’s net income–that is, income after subtracting all your business expenses. In addition to FICA, you’ll pay 2.9% Medicare tax on all your net income. This tax sounds extremely high, and it is.

However, it’s not as unfair to the self-employed as it sounds. All self-employed taxpayers are permitted to take a deduction on their total taxes in an amount that is equal to half of their self-employment tax.

Example: Suppose your single-member LLC business did $70,000 in revenue last year and had $20,000 in expenses. Your net taxable income (or profits) would be $50,000. You’d owe approximately 15% self-employment tax on the $50,000 net business income, or $7,500. In addition, you’d get a deduction on your regular Federal income tax return equal to half your self-employment tax, or $3,750.

The purpose of this is to place the self-employed in the same position with respect to FICA taxes as a corporate owner who paid himself a salary (the double tax for corporations comes in when the corporation pays a dividend to the owners–there’s no corporate double tax on salaries).

How Multi-Member LLCs calculate and pay Self-Employment tax

With a multi-member LLC, the IRS does not treat the LLC as a disregarded entity.

Instead, the LLC will file an informational partnership tax return on form 1065. I refer to this return as “informational” because the LLC will not actually pay any tax as an entity, as it is considered a partnership for income tax purposes.  Net earnings of the LLC are considered pass-through taxation, and each of the LLC members share in the tax burden.

Instead, the purpose of the LLC’s tax return on IRS Form 1065 is simply to figure out the total amount of tax owed, and then each partner pays their share of the taxes. So, while each member will have two tax returns, income tax is only paid once. From this Form 1065 informational tax return, the LLC will issue K-1s, which tell each member how much profit or loss they will recognize.

Self Employment Tax Rates

Social Security (FICA) tax rate: 12.4%

(note: only the first $128,700 of your self-employment income is subject to FICA)

Medicare tax rate: 2.9%

This article on Self Employment tax for LLCs answers the following questions:

  • How do I calculate self-employment tax for my LLC?
  • Do I have to pay self-employment tax for an LLC?
  • Are single-member LLCs treated differently when it comes to self-employment tax?

Taxation of LLCs – Readers’ Questions Answered

Tax Implications of moving an asset from personal property to an LLC

A rental real estate property is owned jointly by a married couple. For liability protection, the asset will be moved to an LLC. What are the tax implications of this move?

Answer

It is a very good idea to get commercial/rental real estate out of your personal name and into an entity such as an LLC (many people used limited partnerships in the days before LLCs became more widely used).

There might be some tax implications, so I suggest you speak with an accountant.

The biggest issue you will have in moving the property to a limited liability company is if the property has a mortgage.

Your mortgage holder is unlikely to simply permit you to quitclaim deed the property over to the LLC. Instead, you’re going to have to work with the lender to either refinance the property or otherwise elect not to exercise the due-on-sale clause in your mortgage.

I have a LLC for snowplow removal but no expenses

by Matt
(XXXX@sbcglobal.net (email changed for your privacy and protection from spammers))

I have a LLC for snowplow removal but no expenses. My friend own a snowplowing business in which I help him. I have opened my own LLC and he pays the company not me but I drive his vehicle and he pays for all repairs and gas. The only thing I have had to purchase is $300.00 worth of insurance. I have a couple questions:

1. I know I have to deposit all the money into a separate account in the LLC’s name, but how can I withdraw money to pay myself?

2. Are you taxed on money that is withdrawn for personal use?

Answer

1. Write yourself a check from the LLC’s bank account.

2. Assuming that the LLC is taxed as a disregarded entity or partnership, you are taxed on the LLC’s net profits–revenues minus expenses.

As you can see from the above equation, the way to lower your taxes is to claim as many expenses from the LLC as you legally can.

It doesn’t matter for tax purposes how much you withdraw.

For some tips on reducing your taxes, I’d recommend taking a look at BasicAccountingHelp.com.

Another way to “learn” the tax code, in a practical sense, is to use small business tax preparation software, such as TurboTax Online for LLCs

TurboTax takes you through a simple question and answer format about your business income, expenses, structure and so forth. From the questions and help guide, you’ll see which expenses are deductible, and how to take the deductions and lower your taxes.

Can I use my LLC as a deduction for my personal income?

Can I use my LLC as a deduction for my personal income taxes, and if so how do I?

Answer

Assuming that your LLC is taxed as a partnership or sole proprietorship, then any losses from the LLC are recorded on your personal form 1040 tax return.

These losses are deducted against your taxable income and therefore should reduce your tax liability.

If the LLC is taxed as a sole proprietorship (e.g. a single member LLC), your LLC’s business income and expenses are recorded on Schedule C of your 1040. If it’s a loss, you have a negative number, which brings down your overall taxable income.

You’ll find the reference to Schedule C on line 12 of your 1040.

If the LLC is taxed as a partnership (e.g. a multi-member LLC), then the LLC will file a Form 1065 Partnership Tax return. Each member will be issued a Form K-1 showing the profit or loss attributable to each member.

The profit or loss from your K-1 will either increase or decrease your taxable income on your Form 1040.

What deductions can be taken under an LLC

by Jerry
(Colleyville)

What deductions can I take for my LLC business?

Answer

Every expense that is “ordinary” and “necessary” to your business should be deducted from your business revenues in order to arrive at your business’s profits.

If you bought it for your business (and it was a legitimate expense), then it should be reported as an expense.

That means everything from rent paid for your store, to web hosting fees, bank fees, wages to employees (including payments to independent contractors), postage, business mileage, etc.

What portion of commission deductions/withholdings are business expense for LLC?

LLC sole owner gets commission from insurance co. as agent. Deductions/withholdings include:

1/2 of self employment Social Security/Medicare (insurance co. picks up the rest)
“Service” charge from insurance co.
401(k) contribution
Disability insurance premium
Errors & Omissions insurance premium

Which of these can the owner deduct as a business expense?

Answer

Is the LLC actually paying any of these withholdings? If not, then they are already being deducted from your revenues. If you were to take them as an expense again, they’d be double-counted.

Check your 1099 and see if the total income being reported by the ins. co. to the IRS already takes the above deductions into account.

If the ins. co. is reporting your E&O insurance premiums as “income” to you, then yes, you ought to deduct that. You’ll have to see what the ins. co. is reporting to the IRS–then I would check with an accountant.

LLC expenses

by Aaron
(Virginia)

I have an LLC and did not make a profit last year. But I have all of my expense receipts including start up costs, meals, entertainment, and etc. How should my tax guy handle this to help with my deductions….personal vs. business?

Answer

Your “tax guy” should file either a Form 1065 (if you are a multi-member LLC filing as a partnership), or a Schedule C (if you’re a single member LLC).

On those forms, he’ll record LLC revenues and all business expenses and come up with a net profit or loss number.

There is a location on your 1040 to put that profit or loss number. That profit/loss number will influence your taxable income accordingly.

when do I pay taxes and how much

by Matt
(Janesville, WI)

I just started my business snowplowing. I will probably make around $2000.00 between now and March. How do I pay taxes, four times a year or just at tax time? Also I am general contractor but take direction from another person who owns his own snowplowing business and brokers the work out. Do I have to pay the SE tax or not?

Answer

Everyone is required to pay quarterly estimated taxes.

As a W-2 employee, your employer withholds taxes from your paycheck and pays the quarterly estimated taxes on your behalf.

If you do not have anyone withholding taxes and paying on your behalf, you will need to do so yourself.

You can determine your estimated tax liability by working through form 1040-ES from the IRS.

As a single member LLC should I pay taxes under my EIN or SS# ?

by Jeff
(IL)

As a single member LLC, should I pay taxes under my EIN or SS# ?

Answer

You are going to file your taxes using your 1040, under your SS#.

Your single member LLC revenues and expenses will be recorded on Schedule C of your 1040. On part D of Schedule C, you can also enter your LLC’s EIN if needed (see the instructions).

LLC after January 1st?

by Mary
(NY, NY)

Hi, I am thinking on forming a single member LLC in NY.
Is there any benefit on waiting until January 1st to file my papers?
thanks

Answer

The biggest advantage is that you wouldn’t have to file a tax return for your single member LLC for 2008.

This could be a disadvantage, however, if your LLC would show deductible losses in 2008. If your LLC would show deductible losses in 2008, then by starting your LLC in 2009, you won’t be able to take advantage of those.

Many people choose to start their LLCs in January because it allows them to have a business year that corresponds with the calendar year.

Starting off the New Year with your company is a good idea. Take the next couple weeks to get your hands on some good small business accounting software and get organized, so that when you officially incorporate your LLC in January, you are ready to go.

Taxing profits from a LLC that have already been taxed

I have a lot of cash in my LLC. I have been paying taxes on the profits for years via a regular payroll so the money in my LLC has been taxed once. Now I have accumulated a lot of capital in my company. This capital has been left over after paying taxes on the profit via my 1040 every year. How do I draw out these profits without paying tax again?. If I take it out as payroll then I have to pay payroll taxes again.

Answer

It depends on how your LLC is taxed: as a partnership, corporation or disregarded entity.

If your LLC is taxed as a partnership or disregarded entity, then you pay taxes on your LLC’s entire profit each year, regardless of how much you payout to yourself in draws and distributions.

If your LLC is taxed as a corporation, then the LLC will pay taxes itself each year, and then, when you take a dividend, you will report those dividends on your personal return as well (just as if you received a dividend from a stock).

Will my business taxes affect my personal taxes

by Kevin O.

(East Orange)

I started a business and i have a tax id for the business. will this effect my personal taxes when i file with my wife.

Answer

Yes, assuming that you are using a pass-through entity like an LLC taxed as a partnership/sole-proprietor.

Your business income will be reported on your 1040 tax return your file with your wife, and will increase your taxable income.

If your business reported a loss for the year, then your business losses will reduce your taxable income.

Reduce Your Chance of Being Audited by 90%

The two primary reasons small business owners choose to incorporate their business are to reduce taxes and avoid personal liability.

However, there is another huge benefit to incorporating that is often overlooked. Corporations and LLCs experience a tax audit at a significantly lower rate than unincorporated businesses.

Incorporated businesses-including LLCs-are audited at a fraction of the rate of non-incorporated, Schedule C taxpayers. Take a look at this chart of IRS audit rates:

Schedule C Business Returns
Under $25,000 3.68%
$25,000-$100,000 2.21%
$100,000 or more 3.65%
Partnerships and LLCs 0.33%
S Corporation Returns 0.30%

Depending on sales, the audit rate for an incorporated business owner reporting on their Schedule C ranges from 2.21% to 3.68%. Compare that to a 0.33% audit rate for LLCs. As you can see, being unincorporated raises your audit rate from about 1/3 of 1% to as much as 3.68%–an increase of more than 10x.

Simply becoming an LLC or S Corporation reduces the audit rate to less than 1/2 of 1%.

Being unincorporated carries an audit risk of about 1 in 30. An LLC’s audit risk, by contrast, is about 1 in 300. Nearly a full 90% decrease from the highest Schedule C audit rate.

Would you incorporate solely to lower your chance of being audited?

Probably not.

However, LLCs have many other advantages, the most important being limited liability protection for your personal assets.

The lower chance of being audited is yet another benefit of incorporation.

Other Articles of Interest

Avoid Double Taxation with an LLC

LLC and Corporate Taxation Compared

S Corporations and LLCs Compared

Paying LLC Taxes

I just formed my LLC in September of this year. I have yet to make a profit due to still trying to purchase necessary equipment, etc. Next year, if I have still yet to make a profit, what do I do in terms of filing my taxes for the LLC?   Also I you don’t make a profit from your LLC, do you pay taxes on the money you put in the business?

Answer

I’m assuming that your LLC is not taxed as a corporation.

In that case, you are going to report a loss for your LLC for this year, and take a deduction on your 1040.

Next year, if you make a profit, that profit will flow through to your 1040 and increase your taxable income.

My suggestion is that you:

1. Keep track of all your business revenue and expenses–this includes keeping all your receipts.

2. Enter this data into Quickbooks.

3. Use tax preparation software like TurboTax or hire a CPA

 

If your LLC has a loss (revenues – expenses = a negative number), then you not only don’t have to pay taxes, but you get a deduction for your LLC’s losses on your personal tax return.

Money you put into the LLC in the form of a capital contribution or loan (e.g. the startup money you put in the LLC) is not “revenue” for the purposes of the calculation above.

If the LLC pays interest to you (or anyone else) on money lent to it, then that interest would be deductible as a business expense to the LLC. The recipient of that interest would report it as interest income.

LLC Tax Questions

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

We have a Florida corporation 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

A corporation or LLC is may not be required to file taxes each year.  It will depend on the state of formation and whether it elected to be taxed as a sole proprietorship, partnership, or corporation – even if it lost money.

In reality however, it’s a good idea to file a return if your corporation or LLC lost money during the year because, under the tax laws, you can carry losses both forward and backward.

Example: If your corporation or LLC made money in 2015 and paid taxes, and then lost money in 2016, you can apply your 2016 losses to your 2015 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 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.

LLC Tax Forms

Below you will find the most common tax forms needed to report your LLC’s profit/loss.

Single Member LLC Tax Forms

Form 1040

This is your standard 1040 individual tax return. Because you’re a single member LLC, you can’t use a 1040-EZ, which is reserved for tax returns that don’t require the additional schedules. As a single member limited liability company, you will need to file additional schedules such as the Schedule C and Schedule E.

Schedule C (Business Income)

As a disregarded entity, your LLC doesn’t report its profit and loss in a separate filing. Instead, your business’s revenue and expenses are recorded on a Schedule C, which is attached to your Form 1040.

Schedule E (Self Employment Tax)

Self Employment tax –which is a combination of Medicare and Social Security taxes — often comes as a surprise to the newly self employed. When you work for someone else, employment taxes are split between the employee and employer. The employer pays half of the tax, and the employee pays the other half. You’re probably familiar with the employee portion of the tax. There are the withholdings labeled “FICA” and “Medicare”. You will pay FICA tax on the first $94,000 of wages and net profits from self employment. You pay Medicare taxes on all wages and net income from self employment.

Multi-Member LLC Tax Forms

Any LLC that has more than two members, will by default be taxed as a partnership. The Form 1065 is the informational tax return prepared by all partnerships.

Form 1065

Download Form 1065 from the IRS’s website. This form is basically a business tax return. You enter your revenue, expenses, and depending on your company’s size, additional forms related to capital accounts. Now, as a pass-through taxation entity, while the LLC files a separate tax return, it does not pay income taxes. Rather, each partner pays their share of the taxes owed (or gets to take a deduction if there are losses). The next form is used to do this.

The K-1

The K-1 form is prepared along with the Form 1065. The Form 1065 tells the IRS how much total income or loss the LLC made during the tax year. The K-1 tells each member the share to the total tax that they have to pay. Each member will be sent a K-1, and the IRS gets a copy as well. The K-1 is similar in effect to the 1099.

The Truth About Business Tax Deductions

There’s a lot of misinformation in books and on the internet about taking tax deductions for business expenses.

Ordinary and Necessary

For example, there are some books that claim that once you incorporate a business, you can deduct virtually any expense. Phone bill? No problem. New desk? No problem. A cherry-red Porsche? Hey, you need it to impress clients, right? Deduct it.

Wrong. The IRS only allows deductions for “ordinary and necessary expenses”. See Internal Revenue Code 162. ‘Trade or business expenses.’

If the what you’re trying to deduct isn’t “ordinary” for your line of business, then there’s no deduction. If the expense isn’t “necessary” for your line of business, then again, no deduction.

Who decides the definition of “ordinary” and “reasonable”? That elusive and everpresent figure in the common law–the reasonable person. Would a reasonable person consider a new mink coat to be an ordinary and reasonable expense of operating a plumbing business out of their home?

In other words, does your deduction pass the laugh test? If think you’re pulling something over the service’s eyes, then you have probably failed the laugh test.

Ultimately, if it goes that far, a federal judge will decide if your claimed expense is ordinary or necessary.

Entities and Deductions

Others claim that you cannot deduct a business expense until you’ve incorporated your business either as a corporation, S corporation, LLC, or partnership. Again, wrong.

Any business, even unincorporated ones, can take deductions for ordinary and necessary business expenses. You report these expenses, along with revenues, on your 1040 Schedule C.

Now, there are some tax disadvantages to this. For one, taxpayers using their Schedule C get audited at about 10 times the rate that partnerships and LLCs do. Secondly, there are ways to minimize your self-employment tax by using incorporating, as well.

No one page article can delve into the minute details of the tax code. If you’re serious about your business and maximizing your take home income, you need to invest in some good tax advice.

It’s 10:30pm, Do You Know Where Your Tax Deductions Are?

The first step is knowing which deductions you can take.

The second step is a system for keeping track of all your expenses.

A shoebox, a “junk drawer”, or “it’s all in my head” are not acceptable systems.

QuickBooks is the leader in small business accounting software for a reason: it works.

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 a 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.

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.

Avoid the corporate double tax with an LLC.

Single member LLCs.

LLCs and S-corporations compared.

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

Understanding Self-Employment Tax for LLCs

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.

Reduce your risk of a tax audit by 90% by incorporating

We found some intriguing results when comparing tax audit rates between individuals filing as Sole Proprietors on a Schedule C vs. LLC members filing a 1065 partnership return. Can you really reduce your chance of an audit by up to 90% simply by forming an LLC?

The truth about taking business tax deductions.

Have Your LLC Tax Questions Answered.

Ask your LLC tax question here, and I’ll answer it right on this site. No obligation, nothing to buy, no email address needed.

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

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