When you organize your business as a sole proprietorship or a partnership, you open yourself up to personal liability on the debt of that business. The idea of an LLC is to limit that personal liability. Within the structure of a Limited Liability Company, your liability is limited to the investment you made in the business and that business’s assets. However, the tax situation of an LLC becomes very complex and it is generally suggested that you convert your LLC to an S Corp, in order to maximize tax deductions.
When an LLC is a single owner entity, it is treated like a sole proprietorship and all income from the business is treated as earned income for the owner. This means that all Medicare and FICA taxes. This means that the owner is subject to 15.3% taxes on all income up to $90,000 and 2.9% on all income above that amount. If the LLC has multiple members, it is treated as a partnership and its earnings are earned income of the partners.
To avoid this, it is necessary to have the LLC become an S Corp. This makes all the company income passive and it is passed on as passive to the owners. For this to happen, the LLC must file an 1102S Corporate Tax Return. This election has to be made within 75 days of the forming of the LLC or the beginning of the tax year. You must be a United States citizen to make this election.
The other option is to file form 8832 and apply to structure the LLC as a C Corp. In this arrangement, income is passed to the stockholders. The LLC can then take advantage of a 15% tax on its first $50,000. The LLC must then file Corporate Tax form 1120. This election must also take place within 75 days of the formation of the LLC or the beginning of the new tax year.
The organizational structure of the LLC addresses how business deductions are handled. These deductions are for things like health insurance, disability insurance, charitable gift deductions, and the use of a vehicle for business purposes. Home office deductions are impacted by the organizational structure of the LLC, also. The main purpose of the LLC is liability limitation, but the tax incentives should be closely scrutinized, as well.
Before making these sorts of decisions regarding your business, it is always suggested that you take some time to consult a business tax specialist.