A Taxing Consideration: LLC
We continue our overview of various North Carolina business entities with a look at the limited liability company (LLC). Last week we looked at the sole proprietorship.
The LLC is still considered a relatively new business structure, although it’s been around for almost 40 years. The LLC, like a corporation and unlike a sole proprietorship, is a separate legal entity from its owners.
It is formed by filing articles of organization with the North Carolina Secretary of State. An operating agreement is strongly recommended, but not required.
As long as it is properly formed, properly capitalized and properly maintained, the limited liability structure should limit the owner’s personal liability for debts and actions of the LLC to the amount the owner invested in the company. LLCs are owned by members and are managed by the managers. Neither members nor managers must live in North Carolina. The company must name a registered agent in NC to accept service. The agent can be any natural person at least 18 years of age living in North Carolina or any company qualified to do business here.
LLCs are desirable because they are flexible as to management participation (active vs. silent partners), initial investments (sweat equity vs. capital investment) and allocation of profits and losses (do not have to be the same as ownership percentage), yet they provide limited liability. It is also possible to make an S-election for an LLC so that it is taxed the same way as an S-corporation. This is valuable when the owner wants to treat some profits as dividends to minimize income tax. LLCs and S-corporations (which we will discuss in detail in another post) are similar in that they both pass through income directly to the owners, but they have vastly different rules on deductions, salary and self-employment taxes.
LLCs do require an annual report to be filed with the Secretary of State. Currently the fee for this is $200 per year.
LLCs are classified as either single-member or multiple-member, and the designation has a big impact on how taxes are reported. LLCs are known as “pass-through entities” because all taxes are passed through to the owners to pay, and are not paid by the company. If you leave profits in the company's bank account at the end of the year -- for instance, to cover future expenses or expand the business -- you must pay income tax on that money.
Single-member LLCs, owned by an individual or married couple, report all income and expenses on Schedule C to the owner’s personal income tax return Form 1040. Multiple-member LLCs, however, must report all income and expenses on a partnership tax return Form 1065. This return is informational only and no tax is paid by the company. Each member pays its proportionate share of tax on the income of the company when it files via Schedule K-1 attached to the owner’s Form 1040 income tax return.
LLCs are responsible for all employment-related taxes and must issue W-2s and 1099s as required. Members of the LLC are subject to self-employment taxes on all earnings or shares of the profits.
