A key challenge to many entrepreneurs is deciding which legal entity they should create to operate a business. Each business structure has its legal and tax implications that will affect the owner in the short and long term, which makes the advice of an experienced accountant fundamental.
In this article, you will discover whether you should start an LLC for tax purposes.
Should I Start an LLC for Tax Purposes? – An Introduction
The first factor to consider about limited liability companies (LLCs) is that each state has specific laws governing the formation and running of this business structure. In most cases, LLCs created solely for tax purposes are formed as single-member LLCs.
Under IRS standards, single-member LLCs are treated as “disregarded entities,” meaning that the income generated by the business entity passes through the company to the member’s tax return.
Hence, the company’s sole owner does not need to file two separate tax returns. In terms of tax treatment, there is no practical difference between a single-member LLC and a sole proprietorship.
If an LLC formed for tax purposes has two or more members, the legal entity will be taxed as a partnership. However, there is an element that might be confusing for many entrepreneurs, which is electing to be taxed as an S-Corp when forming an LLC.
Limited Liability Company vs. S-Corp – Comparing from a Tax Viewpoint
At first glance, S-Corps receive a tax treatment similar to that applied to standard LLCs, as both business structures enjoy pass-through taxation. Still, it is important to point out the existing differences between LLCs and S-Corps.
First, S-Corps allow owners to save on self-employment tax, which is generally not possible when it comes to LLCs. LLC members often have to pay for Social Security and Medicare as part of the tax burden of being self-employed.
The profits generated by S-Corps are not subject to self-employment, whereas the profits generated by LLCs are. However, shareholders (owners) of an S-Corp must necessarily pay themselves a reasonable salary.
The term “reasonable” is subjective, especially as its definition depends on different regulations and circumstances. When S-Corp shareholders pay themselves a salary, they need to file IRS Form W-2 (Wage & Tax Statement) and handle quarterly payroll taxes.
Another important element is the federal unemployment tax (FUTA). The salary of S-Corp shareholders is also subject to FUTA, which can result in lower salaries to reduce the tax burden.
In many cases, IRS auditors may dispute the salaries stated by S-Corp shareholders believing the amount is unreasonably low. Additionally, the rules governing the distribution of shareholder percentages are much stricter for S-Corps.
Ultimately, forming an LLC for tax purposes has several unexpected implications, which require the assistance of a well-versed accountant to guarantee this strategy actually fits your tax-saving plans.
Do You Want to Start an LLC for Tax Purposes? – Immediately Contact an Expert CPA
You do not need to waste time with uncertainty and risk your hard-earned money going through a path riddled with pitfalls. Contact Edward D. Quilca, CPA by calling (786) 310-5582 or emailing [email protected] to identify whether forming an LLC is the best tax-saving strategy for you.
