LLCs - The Basics
The Tax TeleGraf will be starting a series of articles on all things LLCs. My hope is that the Tax TeleGraf becomes a source of easily readable information on learning about LLCs and all things tax. This article is high level information on LLCs; I'm talking 35,000 feet high level but not International Space Station high.
First off, LLC stands for Limited Liability Company. A common mistake (I used to make this back in my intern days) is to call it a Limited Liability Corporation. LLCs and Corporations are two totally different animals so it's important to be crystal clear that if you form a LLC you are not forming a Corporation or running the LLC like a Corporation.
Tax Implications
LLCs are created by filing a certificate of formation through the Secretary of State (could be any state in the U.S. of A). In the great state of Texas the filing fee to create a LLC is a one-time fee of $300. If you create a LLC and you are the only member then what you have formed is a Single Member Limited Liability Company or SMLLC for short. SMLLCs on their own are considered "Disregarded Entities" in the beady eyes of the IRS. Think of a SMLLC as Harry Potter's invisibility cloak. The IRS doesn't "see" your SMLLC as an entity until you choose to be seen. Stay with me here… Just because you formed a LLC doesn't mean your tax situation has completely changed. As a sole proprietor you will still file a Schedule C on your personal tax return as you would without a LLC. There is no separate tax return needed if you are a SMLLC. Wait, so is there any tax benefit on becoming a SMLLC? Nope.
Your newly formed SMLLC is subject to ordinary income tax and self-employment tax (see Tax TeleGraf's article on the #1 Pitfall Small Business Owners Face Here). So how can you be a "seen entity" by the IRS? Have more than one member, elect to be an S-Corp, or elect to be a Corporation.
More than one member and you will be required to file a partnership return (Form 1065)
Elect to be an S-Corporation and you will be required to file a S-Corporation return (Form 1120-S)
Elect to be a C-Corporation and you will be required to file a C-Corporation return (Form 1120)
Limited Liability
So what does the Limited Liability in LLC mean? If you are a small business owner and you have not formed a LLC then any financial debts that you have inside or outside the business will have unlimited access to your personal and business assets. A LLC helps protect you from creditors or judgments against your business property from your personal property. One area that a LLC may not provide personal asset protection from is if you were to act with gross negligence on behalf of the business. This makes sense because if a LLC member intentionally does harm to someone while conducting business you would want that person to be personally held liable because they are no longer acting within their business duties. Only exception is if you're James Bond and have a license to kill (of course I'm kidding).
Like I said in the beginning of the article, this was a high level overview of a LLC. I will be addressing in detail how to form a LLC, LLC entity selection, operating as an LLC, and tax implications in this LLC Series.
