It seems that the latest obsession in the business world is the illustrious LLC, also known as a Limited Liability Company. It has become the latest craze. The LLC is a good choice for many business owners, however, the decision to form an LLC is only the first of many.
The Limited Liability Company is organized at the state level. The Internal Revenue Service does not recognize the LLC as a viable organization. When we create an LLC, the Service allows us three options for federal filings.
1). Sole Proprietorship: This option is available if the LLC is a single member LLC. All income and expenses are reported on the Schedule C of the Form 1040. The single member is not allowed to take a salary or a wage and all net income is subject to self employment tax.
2). Partnership: This option is available if the LLC is a multi member LLC. The income and expenses are reported on a Form 1065. Net income or losses will flow through to each member's Form 1040. Members are not allowed to take a wage or salary but can take guaranteed payments. All net income is subject to self employment tax based on each member's percentage of ownership.
3). S-Corporation: This option is available for both the single member and multi member LLC. The income and expenses are reported on Form 1120S. Net income or losses will flow through to each member's Form 1040. Each member is required to take a reasonable wage or salary which will be reported on a Form W-2 at the end of the year. This option is the only option that avoids paying self employment tax on the net income each year.
Many people visit an attorney or a website like Legalzoom to form Limited Liability Companies. Many times, this option omits the step regarding income taxes. This is an extremely simplified summary of the tax consequences for each option. It is advised to visit with a tax professional to determine which filing situation is best for your individual situation.