When a new business tax client is referred to me, the first step is getting to know the situation. One of my first questions is about the type of business she or he formed. Quite often, the response is “I have an LLC.”
That response isn’t enough information to know how the LLC’s taxes should be filed. An LLC is a legal structure to limit owner liability. For tax purposes, an LLC could file in one of three ways:
1. Sole Proprietorship
Sole proprietors are individual business owners that have not incorporated. Business income and expenses are reported on Schedule C, “Profit or Loss from Business,” and filed with the owner’s individual income tax return. A separate Schedule C must be filed for each business. Net business profits are also subject to the employer and employee portions of the Medicare and Social Security taxes (i.e., FICA).
2. Subchapter S Corporation
A business must qualify to take the Subchapter -S election (i.e., 100 or fewer domestic shareholders and one stock class). One advantage is no double taxation, as with a C Corp. Disadvantages include additional legal documents and no outside capital funding. A Sub-S Corporation files a separate income tax return, IRS Form 1120S. Shareholders receive an IRS Form K-1 for their share of non-wage income and expenses.
Two or more individuals in business together without incorporating must operate as a partnership. Partnerships are required to file a separate income tax return, IRS Form 1065. Partners receive an IRS Form K-1 for their pro rata share of non-wage income and expenses. Partners are responsible for tracking the basis of their shares, which impacts how distributions are taxed.
All businesses with employees must follow the same payroll reporting, tax withholding, and tax remittance rules. Additional tracking and reporting is required for businesses using contactors.
Taxes can be complicated. Knowing how to answer “What is your business type?” might not be as simple as you think. Consulting a qualified tax professional can help keep it all straight, minimize errors, and leave more time for managing your business.