By A.J. Gross, C.P.A., E.A.
In my previous articles we reviewed Corporation and Doing Business As (DBA) business structures. This article is on Limited Liability Companies (LLC).
An LLC is considered a separate entity. This provides the owners limited liability protection. The owners of the LLC are considered members. The LLC is set up by filing Articles of Organization with the State of Michigan.
Unlike a corporation, an LLC doesn’t have required operating formalities. This makes a LLC easier to maintain compared to a corporation. For example, a corporation must establish a Board of Directors, corporate officers, corporate shareholders, corporate resolutions, and corporate bylaws.
Michigan doesn’t require an operating agreement to be filed for an LLC. However, it’s highly recommended an operating agreement is executed. The operating agreement establishes how the LLC will be managed, the duties of members, distribution of profits and losses, how members are added or terminated, and member’s limitations of liability. The operating agreement is important to preserve liability protection, i.e. piercing the corporate veil.
How the LLC is taxed is dependent on the number of owners. An LLC with one owner is considered a Single Member LLC. By default, a Single Member LLC is treated as a disregarded entity for federal income tax. Similar to a DBA business, an LLC treated as a disregarded entity reports income and expenses on Schedule C of the owner’s personal 1040 tax return. All profits of the Single Member LLC are subject to both income and self-employment taxes.
A Single Member LLC can elect to be treated as an S-Corporation or C-Corporation. There may be tax advantages for filing this election. There are strategies for minimizing 15.3% self-employment taxes by paying reasonable wages to the owners and distributing profits. Distributed profits are not subject to 15.3% self employment tax.
An LLC with more than one owner is considered a Multi-Member LLC. By default, a Multi-Member LLC is treated as a partnership for federal income tax. The LLC will be required to file Form 1065, Partnership return. A partnership is considered a flow-through entity. Profits and losses of the partnership are reported on the owner’s 1040 tax return. Generally, all profits of a partnership are subject to self-employment taxes. Although, owners considered limited members may not pay self-employment tax on profits.
A Multi-Member LLC can elect to be treated as an S-Corporation or C-Corporation. Again, there may be tax advantages for filing this election.
It’s important to choose the right business structure. I recommend you review your options with a tax professional before making the decision.
A.J. Gross, C.P.A., E.A. is President of ALG Tax Solutions. A.J. Gross can be contacted at AJGross@algtaxsolutions.com
This column was printed in the December 28, 2014 - January 10, 2015 edition.