A relatively recent form of business allowed by state statute, Limited Liability Companies (LLCs) are popular because, as in a corporation, owners have limited personal liability for LLC debts and actions. In addition, LLCs offer the benefits of partnerships, namely management flexibility and pass-through taxation.
In most states, LLC business owners–called members—may include individuals, corporations, other LLCs and foreign entities, with no maximum number of members. Most states also permit “single member” LLCs. An LLC can be managed by either by the members or by managers. Members can be compensated using distributions of profit or guaranteed payments. In addition, because LLC profits are considered earned income, managing members can deduct 100 percent of the health insurance premiums paid–up to their pro-rata share of LLC’ net profit.
Referred to by the IRS as “pass-through entities,” unlike corporations, LLCs are not separate tax entities and do not pay federal income taxes. Some states impose an annual tax on LLCs, but the number of members in an LLC makes a difference at tax time:
- Single-Owner LLCs – One-member LLCs are treated as sole proprietorships for tax purposes, which means the LLC itself does not pay taxes and does not have to file a return with the IRS Single-owner LLCs report profits or losses on Schedule C and submit it with their 1040 tax returns.
- Multi-Owner LLC – Multi-owner LLCs are treated as partnerships for tax purposes, which means co-owned LLCs do not pay taxes on business income; the owners each pay taxes on their respective shares of profits on their personal income tax returns (Schedule E).
Advantages of LLCs:
- Pass-through taxation.
- Avoids drawbacks of forming a corporation, such as double taxation.
- Limited personally responsibility for LLC debts and liabilities.
- Few ownership restrictions.
- Management flexibility.
- Minimal annual paperwork and fewer formalities than corporations.
- Members must agree in writing to authorize increased ownership in an LLC.
- Customers may view LLCs as a more professional business entity than sole proprietorships or partnerships
Though some types of businesses (banks, insurance companies, and nonprofits, for example) usually cannot be LLCs, and special rules apply to foreign LLCs, most other businesses can become LLCs.
If you’re interested, check your state’s requirements and the federal tax regulations for further information. For information on filing LLC tax returns, dealing with employment taxes and possible pitfalls, refer to IRS Publication 3402, Tax Issues for Limited Liability Companies. Forming an LLC requires filing proper documentation (or “articles of incorporation” or “certificate of incorporation”) with the appropriate state agency, and payment of state filing fees.
Sources: Internal Revenue Service, www.Bizfilings.com, www.Nolo.com, www.gaebler.com