Companies that want personal asset protection for owners but do not want the formalities that a corporation has often structure their business as a limited liability company (LLC). This business entity structure is beneficial no matter the number of business owners, especially as a single member LLC.
What Is A Single Member LLC
Many startups with sole owners choose to operate as a sole proprietorship because of its simplicity and ease of setup. However, for those who want to legally structure their business, a single member LLC may be a better option. As the name suggests, this type of LLC is for those with one owner only. The owner of an LLC is called a member.
One of the advantages of this structure that sets it apart from a sole proprietorship is that it provides a corporate veil, which is similar to that of a corporation. Generally, the corporate veil refers to an imaginary curtain that divides the actions of the company from its owners. An LLC member will not be held personally liable for the actions and obligations of the company.
Federal Income Tax
By default, the Internal Revenue Service (IRS) treats single member LLCs as disregarded entities when it comes to taxation. It means that, similar to sole proprietorships, the company will not be taxed at a corporate level. Instead, the member will be paying and reporting taxes for business income and losses as part of their personal tax return. The tax rate will depend on the amount of income.
To report for federal income tax, the LLC member will have to submit Schedule C: Profit or Loss From Business and Form 1040: U.S. Individual Income Tax Return to the IRS. Schedule C contains information about the LLC’s annual income, expenses, profit, and losses. For Form 1040, the LLC member should include the net profit or loss shown on Schedule C.
Self-Employment Tax
The IRS considers the owner of this type of LLC as self-employed. So the income that an LLC member receives from the company will be subject to federal self-employment taxes. That is in addition to the income tax. The rate is at 15.3%, and it is composed of two parts. The first one is for social security, which is 12.4%. The second is for Medicare, which is 2.9%.
For this tax, use Schedule SE: Self-Employment Tax and submit it with Form 1040 and Schedule C to the IRS.
C Corporation And S Corporation Tax Treatment
In some cases, single member LLCs may choose to be classified as a C corporation for taxation purposes. That means the company will be paying taxes on gross income at the corporate level. This option is often chosen by an individual with a higher income or whose LLC has a high profit.
If an LLC becomes classified as a corporation, its members will become similar to shareholders, so they will not be considered self-employed. Self-employment tax will only be for a member who works as an employee of the company.
Another option is to elect S corporation (S corp) taxation. In this case, the company will still not be paying income taxes at a corporate level. But, unlike an LLC, an S Corp can divide business profits into salaries and dividends.
Dividend distributions are often preferred because they are not subject to payroll taxes. Employment-related taxes only apply to salaries. However, it is important to note that the division between dividends and salaries should be reasonable as determined by the IRS.
Employment Tax
If a single member LLC has employees, it needs to get an Employer Identification Number (EIN) from the IRS. It will also have to file employment tax forms and pay any related withholding taxes. Aside from federal employment taxes, check local laws because states may also impose employment taxes.
Unemployment Tax
Companies that have employees should report and pay federal and state unemployment taxes as well. At the federal level, the tax rate for 2020 is at 6% for the first $7,000 each employee has earned. If a business qualifies for the maximum tax credit, which is 5.4%, its federal unemployment tax liability will be reduced to 0.6%.
As for the state unemployment tax, check the specific rate based on the laws of the state where the company is registered.
State Income Tax
Every state has different laws governing LLCs, so taxation and rates will also vary. In most cases, it will be necessary to register with the state Department of Revenue or a similar governing agency. Most states base income taxes on federal income tax liabilities, but they modify these for state rates, too.
Other Possible Taxes
Some also impose franchise tax, business excise tax, or privilege tax. Companies selling products or offering certain services are also likely to be required to pay sales and use taxes.
Other Obligations
Aside from reporting and paying taxes, a single member LLC will have other compliance obligations. One of these is the annual or biennial report.
In many states, the law requires LLCs to file reports with the state governing agency. This document will include basic information related to the business, such as the company address, the name and address of the registered agent, and the name and address of the company owner. Not only will this report keep the state updated about the company, but it will also ensure that the LLC remains in good standing status with the state.
Most states provide readily available forms that companies can fill out. This submission comes with a filing fee that will also vary depending on the state where the LLC is registered.
Running single member LLCs comes with multiple responsibilities. For some, it may be hard to focus on all aspects involved. In such cases, it may be best to leave certain tasks to a reliable third-party organization like DoMyLLC.
Our team of experts has the skills, knowledge, and experience necessary to handle state compliance obligations. Depending on the clients’ needs, we can also come up with a personalized solution.
With our help, company owners can focus more on growing their business and take care of tax obligations. Contact us to find out more.