LLCs and Taxes 101

Taxes

A Limited Liability Company (LLC) is generally considered to be the most flexible business entity. When you’re not sure which type of entity is suitable for your business, an LLC is definitely what you should start with (unless you are starting a company for a profession that requires a corporation).  

Even though LLCs are considered to be the most flexible business entity, they are also one of the most complex entities because of how they are taxed.

 

Guarantee Payment

Owners of an LLC are called members and each member has an interest in the LLC. Unlike corporations, where shareholders of a corporation can be employees, LLC members cannot be employees of the LLC and have a membership interest in the LLC business. Rather, members are compensated through a function called Guarantee Payment in lieu of a salary (employee) or a dividend (corporation). Any LLC member who receives guarantee payments needs to include that income on their individual income tax return, and the payment is reported as earned income from a business that is subject to both self-employement tax & income tax.

One downside of an LLC is that income from guarantee payments cannot be offset by related business expenses. This means that if you have a business expense, you cannot deduct the business expense on your individual tax return.

 

S-Corporation Election

One way around the guarantee payment problem is to have the LLC elect to be treated as an S-Corporation for tax purposes. This can be done when there are less than 100 members who are all individual “U.S. persons” (Green card holders or US Citizens). Once elected as an S-Corporation, the members (shareholders now because the IRS considers them shareholders of an S-Corporation) can now be treated as employees when providing services to the company. The general managers of the LLC are then required to receive payroll and be properly compensated for the services provided.


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Daniel Lu

Daniel Lu - Certified Public Accountant

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