The IRS considers a single-member LLC (SMLLC) to be a disregarded company. This implies that the LLC’s status is ignored for federal tax purposes, and the company is subject to pass-through taxes as if it were a sole proprietorship.
Despite being disregarded by the federal government when it comes to taxes, all 50 states and Washington, D.C. permit the formation of LLCs with just one member. As a consequence, when it comes to limited liability protection, they are considered as a different corporate entity from its owners. In this regard, they are analogous to multi-member LLCs, which are protected as corporations but taxed as partnerships.
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Tax on Self-Employment
The proprietor of an SMLLC is not considered a firm employee. SMLLC owners collect earnings from their capital accounts rather than getting a salary with income and payroll taxes subtracted. This money is not taxed when withdrawn, but the owners must pay all relevant state and federal taxes on a quarterly basis.
An SMLLC owner must pay self-employment tax in addition to income taxes to cover both the employee and employer portion of Social Security and Medicare, often known as FICA taxes.
Every firm must pay FICA taxes on a share of its earnings. The FICA tax rate is now 15.3%. This tax is shared between the employer and the workers in a firm with employees. When you work for yourself, as SMLLC owners do, you are accountable for the whole 15.3%. For income tax purposes, the employer component of this tax is deductible.
Taxation of an SMLLC with Employees
One exception to the federal government’s disregarding corporate status for SMLLCs involves enterprises with workers. The IRS considers an SMLLC to be a different company from its owner for the purposes of paying employment taxes, which cover all taxes withheld from your workers’ paychecks and paid to the federal government.
These taxes must be filed and paid separately from your personal taxes, using your company’s name and Employer Identification Number (EIN). This special treatment extends to some excise taxes owing by your SMLLC.
The Benefits and Drawbacks of a Neglected Entity
Being a forgotten creature has both advantages and disadvantages. The following are the primary advantages of this status:
Pass-through taxation: As previously stated, disregarded entities are taxed as sole proprietorships. This implies that all corporate profits, losses, costs, and credits are passed through to the owner and recorded on their personal tax return. This not only simplifies tax reporting, but it also prevents the double taxation that certain business earnings face.
Liability Protection: Despite being overlooked by the IRS, SMLLCs have the same limited liability protections as multi-member LLCs and corporations. Personal assets of a business owner are usually shielded against legal action brought against the corporation.
Flexibility is also another desirable attribute of an SMLLC. While the default option for this company form is disregarded entity status and pass-through taxes, an SMLLC owner may alternatively decide to be treated as a S corporation or a C corporation. Each categorization has distinct tax structures and duties, allowing a business owner to pick the option that is most financially favourable to their company.
While an SMLLC is a popular company form, it is not suitable for everyone. Consider the following drawbacks:
Increased paperwork and formalities: If you are a sole proprietorship thinking about becoming an SMLLC with no workers, there will be additional charges and paperwork. Even if you are the only owner of the LLC, you must properly separate all of your commercial and personal assets and establish an operating agreement to explain how your firm operates. There are additional yearly reporting obligations to meet, as well as fees to pay to keep your position.
A thinner corporate veil: An SMLLC has the same limited liability protection as a multi-member LLC on paper. In reality, however, an SMLLC’s corporate veil has proved simpler to breach. This implies that in the case of a legal action against a firm, the personal assets of SMLLC owners are more susceptible. The reason for this is that SMLLC owners may find it more difficult to establish a clean boundary between themselves and their enterprises.
When does an entity cease to be ignored?
An SMLLC might lose its neglected entity status in a variety of ways.
It has the option of being taxed as a corporation.
It may add at least one more member to become a multi-member LLC.
If it fails to comply with all state requirements regulating this company kind, it may lose its status as an SMLLC and so become a disregarded entity.