Charlotte LLCs - 3 key Questions to be Answered at Setup Part 2
In part 1 of this post, the choices an owner has to make when setting up and LLC were highlighted. This post features the choices of entities available to LLCs and highlights how each is treated for taxes.
Sole Proprietorship - The simplest structure of all the choices. The owner, if he has no employees, will have no payroll, or payroll tax reports to worry about. They also will not have to file a separate year-end corporate tax return or partnership return for the LLC. The year-end taxes are determined on your personal return. A Schedule C for the LLC is filled out and is part of your 1040 personal return. The downside of a Sole Proprietorship, is the owner will have to pay self-employment taxes on the income earned from the LLC. Also, the owner cannot take W2 wages fro the LLC Sole Proprietorship. The owner will have to track net income carefully and pay estimated quarterly taxes based on the net income of the business each quarter. If he or she does not pay attention to the net income generated by the business, during the year, and fails to pay estimated quarterly taxes they could be looking at having to write a very large check in April when they file their personal tax return. Taxes, from the business, can be 25% to 60% of the net income of the business depending on your personal income tax bracket. For example, If you haven't paid any taxes during the year and the business generated $50,000 in income, The self-employment taxes would be approximately $7,650; federal taxes at the 15% tax bracket would be an additional $7,500; and if you pay state taxes at 7% on earned income you would be looking at an additional $3,500. In this example, come April, if no estimated quarterly payments were made, you'd have to pay almost $18,650 in taxes on $50,000 of business income. This is assuming you are at the low end of the federal income tax bracket.
Partnership- When two or more individuals form an LLC, it will default to a Partnership. A Partnership, like a Sole Proprietorship, if it has no employees, will have no payroll, or payroll tax reports to worry about. At the end of the year, the LLC will be required to file a Partnership return. The net income of the LLC will be divided up amongst the Partners based on the percentage of ownership. Each Partner receives a K1 reflecting his or her share of income (or losses) from the Partnership. Each Partner is required to record the income (or losses) they earned from the LLC Partnership on their personal tax return. The Partners pay self-employment taxes, federal taxes and possibly state taxes. The amount of federal, and in some cases state taxes, paid by each Partner is determined based on their personal income tax bracket. Because of this, the total amount of taxes paid from Partner to Partner can vary, since each Partner's personal tax return will be vastly different. It is possible for one Partner to have to pay little to no taxes on income earned by the Partnership, while other partners could have to pay up to 35% in federal taxes. As with a Sole Proprietorship, each Partner will have to track net income carefully, and pay estimated quarterly taxes. Like the owner of a sole Proprietorship, If a Partner does not pay attention to the net income earned by the LLC during the year, the Partner may have to write a sizable check for taxes. Like a Sole Proprietor, a Partner may have pay anywhere from 25% to 60% in taxes on their share of income earned from the Partnership.
S Corporation- A corporation that passes corporate income, losses, deductions and credits through to shareholders for federal tax purposes. In other words, the earnings or losses by the S corporation, are passed through and recorded on an owner's personal tax return. The owner pays taxes on the earnings based on his or her own personal tax rate. Unlike a Partnership or Sole proprietorship, an owners of an S Corporation must, by law, take a reasonable and customary salary. This type of entity allows the owner to take W2 wages and have income tax, as well as social security taxes, and Medicare taxes to be deducted from their wages. It also allows them to take some compensation out as distributions, which are not subject to social security, Medicare taxes. A CPA should be consulted to help determine an appropriate salary and reasonable distributions.
C Corporations- The C Corporation is the only structure where the income earned by the Corporation does not flow through to the owners personal tax return. Instead, the corporation is recognized by the IRS as a separate taxpaying entity. When people talk about the corporate tax rate, they are referring to the tax rate paid by C Corporations. One of the biggest downsides of a C Corporation, for business owners, is the double taxation. The Corporation has to pay taxes on earned income. If the company then distributes any of its earnings, as dividends to its shareholders, the shareholder has to pay taxes on the dividends received. This results in income being taxed twice, once at the corporate level and again by the shareholder on their personal tax return. Certain circumstances dictate the selection of a C Corporation for the LLC.
It is always advisable to speak with a CPA when setting up an LLC and choosing the most beneficial tax treatment of the LLC.