Understanding and tackling LLC taxes in no time flat
As a new business owner, it's easy to fixate on business expenses. They are, after all, a recurring concern that can eat into your bottom line. But after forming a limited liability company (LLC), there's an even bigger fish to fry: LLC taxes.
Income tax returns are easy when you're an employee. But as an LLC owner, your days of simple personal tax returns are over. Now you're looking at a drastically different tax scenario that can change depending on your business partnership, state, and more.
Before diving into the specifics of paying LLC taxes, let's examine C and S corporations, as they're commonly confused with LLCs.
LLC taxes vs. C Corporations vs. S Corporations
When it comes to the world of business taxes, one common question is, "How do LLCs and various corporations differ?" An LLC and corporation can seem similar at first, as both structures typically involve a number of members, an organized business structure, possibly a letter of intent, and taxes a world apart from those of an employee or freelancer. But as far as tax purposes are concerned, the structures couldn't be more different.
A C corporation is frequently used by those wanting to go public and attract shareholders. But the net income of a C corp is subject to double taxation. This means a C corp is first taxed at a corporate level. Then, the shareholders of the C corp pay personal income tax on their earnings. This means the Internal Revenue Service (IRS) gets to double-dip.
An S corporation is similar to a C corp in that it allows shareholders to invest. But unlike a C corp, an S corp is taxed only at the shareholder level. This means the business income bypasses corporate tax, and only shareholders pay taxes.
Lastly, there's the LLC. LLCs aren't subject to the same strict structural standards as a C corp or S corp, meaning there doesn't have to be a board of directors, you don’t have to pay yourself a salary, and so on. But this also makes LLC taxes a different beast entirely.
LLCs have the freedom to be taxed like an S or C corp, meaning either of the above situations can apply. However, they can also be structured as something else entirely.
Unlike corporations, LLCs aren't subject to a single set of IRS taxation rules. Instead, LLCs have the freedom to structure their business and be taxed accordingly. As a result, there are a few ways LLCs can be taxed.
A single-member LLC is an LLC with exactly that: a single member. This structure allows an individual to operate a business as a separate legal entity from the company itself. This allows the owner's personal assets to be free from seizure in the event of a lawsuit or tax liability.
A single-member LLC can structure as a corporation, in which case it would be taxed as such. But, if you elect to remain a single-member LLC that's organized as an LLC, the IRS will tax you as what’s known as a disregarded entity. This means you will be taxed like a sole proprietorship and will pay personal income tax.
Multi-member LLCs feature any number of members with varying responsibilities and levels of ownership. Unlike single-member LLCs, a multi-member LLC is taxed like a partnership.
In a partnership, no corporate taxes are paid by the business itself. Instead, each member of the partnership files a personal income tax return for their share of the profits, based on the operating agreement drafted when the LLC was formed. Depending on each member’s level of ownership and income, each partnership return could look different.
When filing taxes, each member of the LLC will use Schedule E (Form 1040) to report supplemental income and losses. They'll also need to use Schedule K-1 (Form 1065) to report their share of taxable income for their individual tax return.
Filing taxes as an LLC doesn't have to be confusing or difficult. Once you know the type of LLC you'll run, you can take note of the filing methods and begin preparations. However, a big part of preparing is ensuring your books are in order. Let’s take a look at some LLC bookkeeping tips.
LLC accounting tips
There's more to filing taxes as an LLC than simply keeping tabs on your LLC's income and knowing what kind of tax entity you are. Keep the following in mind the moment you form your LLC, and you'll be ready for a smooth tax season:
- Hire a bookkeeper: They can be either part-time or full-time. A full-time bookkeeper might be too expensive or unnecessary for now, but even a part-time freelance bookkeeper can keep your finances in order and free you up to focus on growing your business.
- Ensure you have a business bank account: This will prevent the commingling of your funds. A business bank account will reduce the chances of irresponsible spending or misuse of business funds, and make it easy for your bookkeeper and tax accountant to go through your expenses. Be sure to research the best banks for LLCs, as this business type may have specific needs.
- Get a business credit card: This will also help prevent the commingling of your finances. A business credit card will make it even easier to keep track of your business spending, which is useful for your bookkeeping and will help your accountant during tax time.
- Develop an expense policy: Poor spending habits can destroy any business. Develop an expense policy early on to ensure any partners or employees know how to utilize company accounts and credit. This will prevent excessive spending and, as a result, make for an easier accounting process.
- Utilize accounting software: Accounting software will typically sync with your credit cards and other systems to automatically track expenses. But even if you can’t afford a professional-grade tool like Quickbooks or Xero,a simple spreadsheet can help you keep your finances in order. Just be cautious when manually entering data, as errors can happen.
- Be aggressive with invoices: Unpaid invoices can quickly tie up cash flow, create a backlog in your books, and turn into a headache. If you give customers 30 days to pay, don’t wait until day 30 to send a reminder. Send a reminder after a week.
- Don’t save taxes for tax time: It’s easy to put off your taxes until tax season is nearly here. Start prepping months in advance by gathering financial records and speaking with your bookkeeper or accountant. This will help ensure there aren’t surprises when it’s time to file your taxes.
A little bookkeeping goes a long way. Establishing healthy financial habits as early as possible allows you to increase your chances of a healthy cash flow, avoid overspending, and give your business the healthiest life possible.
LLC taxes, like many things in business, are quite simple once understood. When in doubt, contact an accountant or business consultant. If you have a multi-member LLC, designate someone as your financial expert. This will allow you to focus on other matters and give an accountant or bookkeeper a central contact for your business.
LLC taxes might be time-consuming and daunting at first, but in due time you'll become a self-made LLC tax pro.