The Lowdown on LLC’s

What they are, how they are taxed and why you need one for your business.

For many business owners, they are told that the best way to go about running their company is as an LLC. But what does this really mean and how will it change your taxes? We'll walk through all of those ins-and outs, so you know whether or not becoming an LLC makes sense for YOUR particular situation!

What is an LLC and why is it important?

An LLC is a legal classification that separates the business from the business owner. For example: if something happens with your business you won’t be in danger of losing your house and car; those things belong to "you" as an individual person rather than part of your business. So, by creating our own limited liability corporation (LLC), individuals are better protected against such circumstances where one suffers losses due solely from owning the business. It is important to note, it helps decrease the personal liability, it does not alleviate it entirely. It is best to speak to an attorney on the specific liability in your situation, and what assets could still be vulnerable.

How do you form an LLC?

LLC’s are formed at the state level, preferably in the state your business primarily operates. This does not mean you cannot operate in other states as well though! These are the best ways to form an LLC:

1.     Do it yourself on your state’s website. Every state is a bit different and some are more streamlined than others, but it is definitely a doable option. Make sure you are reading everything carefully and print all relevant documents to PDF as you go to save as records.

2.     Use Legal Zoom. Legal Zoom is a trusted online legal service that can help you with the whole process. They use flat rate fees, so you will know up front how much you will be investing which I love!

3.     Find a local attorney. Prices will vary greatly for this as most attorney’s bill hourly so just make sure you understand their hourly rate and the estimated hours, or better yet try to get them to agree to a flat rate if you take this route.

How much does an LLC cost each year?

 This varies by state, but most range from $50 - $250 per year, a relatively inexpensive investment to help protect your personal liability. However; there are a few states with fees that are over $500 per year (looking at you Massachusetts’s and Illinois).

How am I taxed an LLC?

 Like we discussed above, an LLC is a legal classification that has much optionality for taxes.

Once an LLC, you may be taxed as the following:

1)    Individual - If you are a single member LLC, this is the default status unless you elect otherwise

• How: If you do not elect any other status, by default you will be taxed as an individual

• Tax Filing: Form 1040 + Schedule C

  • Form 1040 is the normal individual tax return you would file regardless

  • Schedule C is a supplement to a 1040 to report business income and expenses

2)    Partnership - If you are a multiple member LLC, this is the default status unless you elect otherwise

• How: If you do not elect any other status, by default you will be taxed as a partnership if your LLC as more than one member

• Tax Filing: Form 1065 + K-1

  • Form 1065 is the partnership tax form

  • The K-1 is generated from the 1065 to show the income allocated to you as a shareholder (think of it as a W-2 for business owners). The income will be included on your individual return.

3)    S-Corp

• How: Elect to be an S-Corp by filing Form 2553. Elections must be made 75 days of your intended date. So, if you want to start as an S-Corp on January 1st (which I would recommend) you will need to file the Form 2553 by March 15th or file a late election request. I highly recommend working with your tax accountant to see if an S-Corp is right for your business and to assist with the election process.

• Tax Filing: Form 1120S + K-1

  • Form 1120S is the corporate tax return for an S-Corp

  • The K-1 is generated from the 1120S to show the income allocated to you as a shareholder (think of it as a W-2 for business owners). The income will be included on your individual return.

4)    C-Corp

• How: Elect to be a C-Corp by filling out form 8832. This is NOT something I would recommend for most small businesses, and certainly not something I would advise doing without a trusted tax advisor. This option is primarily used by larger companies with complex structures for tax planning purposes. For most smaller or start-up business looking to raise venture capital funding or bring on larger investors, I would recommend actually converting to a corporation.

• Tax Filing: Form 1120

  • Form 1120 is the corporate tax return for a C-Corp and profits are taxed at 21%

  • Individuals would be taxed from any payroll or dividends received

My professional opinion is that every business should form an LLC instead of doing business as a sole proprietor. If you have a really small side hustle and happen to live in one of the states with higher annual LLC fees, I do understand not making the switch in the short term; but I would encourage you to at least obtain an EIN number (learn how here!). Forming an LLC not only helps protect your personal liability, but it provides a sense of legitimacy to your business you are working so hard to create!