April is home to two important dates, my birthday, and tax day which traditionally falls on my birthday (4/15). While my birthday is a day of celebration, as a small business owner dealing with taxes is one of the most undesirable parts of business. Many of us come from a 9-to-5 where taxes are straightforward – to a maze of self-employment taxes, payroll taxes, and state taxes.
The entity you choose for your small business has a huge effect on how you’re taxed. Limited Liability Company (LLC) is a popular entity choice for many small businesses (note: if you are setting up an entity you should seek a professional opinion to ensure you are making the best choice for your business) because it is easy to set up and provides flexibility that traditional corporations do not – but if you’ve chosen an LLC do you know all of the tax advantages or disadvantages? Here are a few to consider:
LLCs Do Not Have a Specific Tax Category
Because LLCs are fairly new entities, the IRS does not have a specific tax category for this business type. LLC members have a choice when it comes to taxes – they can be taxed as partnerships or corporations. Changing your filing status after the initial election requires a request to the Internal Revenue Service. If LLC’s pay taxes as a partnership, meaning the members pay taxes individually, the LLC still has obligations to the IRS. Each year, LLCs must file a Form 1065, which states their earnings, profits, and losses.
Taxes Assessed on Entire Distributive Share
However members’ distributive shares are divvied up, (50/50, 70/30 etc.) the IRS treats each LLC member as though the member receives his or her entire distributive share each year, even if the LLC does not distribute the money to the members. So if an LLC elected to leave all profits in the business, each LLC member is liable for income tax on his or her rightful share of that revenue.
LLC members are required to pay self-employment taxes directly to the IRS i.e. contributions to social security and Medicare. However, owners who are not active in business, meaning they are not providing services or making management decisions,– that is, those who have merely invested money — may be exempt from paying self-employment taxes on their share of profits.
How Are Property Contributions Taxed
In general, the contribution of property, for instance delivery vehicles or computers, to a LLC in exchange for a membership interest, is a tax-neutral event if the LLC is taxed as a partnership – neither the contributing member nor the LLC is taxed.
“You don’t pay taxes–they take taxes.”–Chris Rock