The Entrepreneur's Guide to Understanding LLC Frameworks

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Could navigating the tax labyrinth of LLCs be the key to safeguarding your assets and ensuring your small business flourishes? That's the golden nugget we're hunting in our Espresso Tax and Small Business Essentials podcast. Join me, Eric Bonney, seasoned CPA and founder of Harvest Tax and Accounting Services, as I share over 28 years of expertise to guide you through the essential tax knowledge every LLC owner needs. From single-member entities to complex partnerships, we dissect the default classifications, tax advantages, potential pitfalls, and the crucial decisions that could shape your business's financial future.

This episode is a treasure trove for both the solo entrepreneur and the multi-member LLC team, as we examine the impact of different tax elections, such as C and S Corporations, on your bottom line. We'll unravel the mysteries of self-employment taxes, reasonable compensation, and distribution protocols. Plus, I'll stress the importance of professional guidance when making these critical tax decisions. Don't miss out on these insights – they could be the difference between a thriving business and a tax nightmare.

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Episode Transcript

Speaker 1 (00:03):
Welcome everyone to Espresso Tax and Small Business
Essentials, where we are brewingup success for the owner-led
entity by providing education onuseful tax strategies and other
essential business topics.
I am your host, eric Bonney,founder of Harvest Tax and
Accounting Services and a CPAwith over 28 years of experience
servicing business owners likeyourself.
Each week, I will take a lookat the most pressing tax issues

(00:26):
and business questions thatsmall business owners are facing
.
Welcome everyone.
Today we are going to betalking about limited liability
companies, or LLCs, and how theyare taxed.
A limited liability company isa legal entity that has been
registered with your state andtypically owners will do this so

(00:47):
that they can shield theirpersonal assets and help give
themselves a little bit ofliability for things that may
happen inside the business.
We start every one of our newpartner business meetings with
the question of how are youtaxed, and typically that will
be answered in a fashion such aswe're an LLC, we're taxed as an

(01:08):
LLC.
Well, an LLC can be taxed inmany ways depending on the
number of owners that are in theLLC and elections that you may
have made.
So it really isn't just assimple as we're taxed as an LLC.
So how are LLCs taxed?
It depends on the number ofowners.
Typically, First off, if youare the single owner of an LLC,

(01:33):
then that LLC can be taxedeither as a disregarded entity
or it could be taxed as a Ccorporation or also as an S
corporation.
The default classification fora single member, llc, is called
a disregarded entity and whatthis means is that if you are a
business, you're going toprobably file a Schedule C on a

(01:54):
1040.
If it's a rental property, thenyou're probably going to file a
Schedule E, or if you are infarming, then you're probably
going to file a Schedule F.
While this is the leastcomplicated of all of the
methods, it also has a downsideof everything that is going to
be on.
That LLC, from an incomestandpoint, is going to be
subject to self-employment taxif it is an active business,

(02:18):
which means that the businessowner is going to pay an extra
15% tax and that may or may notbe the best option for them.
The member could decide to filea Form 8832 and elect to be
taxed as a C-Corporation, so theC-Corporation.
One of the biggest downsides tothat is double taxation.

(02:40):
There's going to be a flat 21%tax that is going to be paid by
the corporation itself, but thenyou're also, as owners, are
going to be taxed on any wagesthat you take out of that
business and you're going to betaxed on any dividends that you
may take out of the business.
One main benefit of a Ccorporation is that there is no

(03:01):
limitation to the number ofshareholders in a C corporation.
Also, there's no limit as towho can be an owner of a C
corporation, and many times Ccorporations will be used as an
LLC for those individuals thatare looking to take their entity

(03:21):
and get a lot of funding orlooking to take that entity
public.
Another option is that youcould file Form 2553 to make the
tax election to be taxed as anS-Corporation.
Now, this must be done, usuallywithin the first 75 days of the
taxable year.
If you don't get it in withinthe first 75 days, there are

(03:45):
some late filing provisions thatyou can do.
If you're looking at somethinglike that, I highly encourage
you to talk to your taxprofessional.
If you're looking at somethinglike that, I highly encourage
you to talk to your taxprofessional.
Biggest benefit to being taxedas an S-corporation is that you
are no longer going to besubject to the self-employment
tax for any income that flowsthrough to you individually.
Again, there's going to be somedownsides and drawbacks to this

(04:06):
.
There's going to be a separateentity that needs to be filed
and that tax return is going tobe an 1120S.
All active members in the LLCwill need to be paid a
reasonable compensation.
So now you have payroll issuesand any distributions to the
owners must be done in a prorata basis.
What I mean by that is is thatif you've got two members that

(04:29):
are 60-40 owners and you'regoing to take money out of the
business, then that money has tobe divvied up in that 60-40
percentage.
So additional complications fora S-corporation are again all
active members must have areasonable compensation.
You also have a limited numberof members that can be a

(04:53):
shareholder in an S-Corporation.
Typically, you are limited to atotal of 100 owners.
Most of our partners don't haveto worry about that, but it is
something that you need to beaware of.
Also, most of the members thatare inside an S-Corporation must
be US residents or have apermanent residence here in the

(05:14):
US.
The other big issue with anS-Corporation is that you are
limited to only one class ofstock.
Now you can have voting andnon-voting stock.
But what they mean by one classof stock is that you cannot
have something like you can in aC-Corporation, where you can
have a preferred stock or acommon stock, where one owner of

(05:39):
the LLC has preferentialtreatment in getting money from
the business, and we discussedearlier already about how the
distributions must be in afashion similar to the ownership
of the LLC.
Now what happens if we havemultiple members in an LLC?

(06:00):
If we have multiple members inan LLC, then the default
classification is going to be apartnership that again is going
to file a separate entity return.
Separate entity return.
That is going to be a form 1065and all active members inside
that entity are going to alsostill be subject to
self-employment tax, so they'restill going to most likely pay

(06:22):
an additional 15% tax.
It does offer a little bit offlexibility when you are going
to be taking money out of thebusiness and, again using our
example from earlier, if you'vegot two partners that are 60-40
owners, if one person wants totake money out of the business,
generally speaking they can takethat money and the other

(06:43):
partner does not need to takethat money.
They could still file that form8832 and decide that they want
the entity to be taxed as a Ccorporation Again has all the
same benefits and downsides thatwe discussed earlier flat tax
of 21%, but still have thedouble taxation.
And then, finally, they couldstill also file the Form 2553 to

(07:08):
decide that they want to betaxed as an S corporation Again
all the same benefits anddownsides, again.
At that same issue of you needto make sure that your
distributions are in accordanceto your ownership and active
members still need to be on areasonable compensation.
So if you're looking at an LLCand you're looking to decide

(07:32):
whether or not you want to makean election, I highly encourage
you to have a conversation withyour tax professional about what
is going to be the best taxbenefit for you in your specific
circumstances.
Thank you for joining me todayfor this episode of Espresso Tax
and Small Business Essentials.
Don't forget to sign up for ourmonthly newsletter and if you

(07:53):
have a specific topic that youwould like to hear me cover here
on the show, please send me anemail at espressotax at
harvestcpafirmcom.
There are links in the shownotes for both the monthly
newsletter and how to request atopic.