When entrepreneurs start up businesses, many favor LLCs because they are easier to operate than corporations. In fact, more than a million LLCs are now registered in the state of Florida.
If you’re an owner, it is imperative to understand how a limited liability company is structured according to tax law. A limited liability company is considered a “pass-through” tax entity.
WHO ARE THE “MEMBERS” OF A LIMITED LIABILITY COMPANY?
Unlike a corporation, all of an LLC’s profits and losses must be reported on the personal tax returns of the owners or “members,” because a limited liability company pays no federal income taxes.
Instead of “shareholders” or “partners,” the owners of a limited liability company are legally referred to as “members.”
In Florida, LLC members can also choose either a member-managed or a manager-managed organizational structure, and that choice should be spelled out in the LLC’s operating agreement.
DOES YOUR LLC NEED AN OPERATING AGREEMENT?
A limited liability company should be governed by an operating agreement that specifically spells out how the LLC will be funded, managed, and operated.
If your limited liability company has no operating agreement, have one prepared by a business attorney – right away. Every LLC needs to have a clear and precise operating agreement.
Because the profits of a limited liability company “pass through” to the members, the Internal Revenue Service calls LLCs (and partnerships and sole proprietorships) pass-through tax entities.
HOW ARE LLCs CLASSIFIED FOR TAX PURPOSES?
Here’s how LLCs are classified by the Internal Revenue Service for federal income tax purposes:
1. An LLC with one member is classified as a sole proprietorship. A lone limited liability company member will file a 1040 return and report losses and profits on a Schedule C.
2. An LLC with multiple members is classified as a partnership unless the LLC chooses to be treated as a corporation. Like any partnership, the LLC must submit Form 1065 and a Schedule K-1.
A limited liability company must report losses and profits that pass to members on Schedule K-1 forms. Every member then reports that information on a 1040 form and attaches a Schedule E.
EXACTLY HOW ARE LLC MEMBERS TAXED?
Limited liability company members are taxed on their distributive share of the profits.
A distributive share equals the percentage of each member’s interest, but limited liability companies may distribute profits as they please in what the IRS calls “special allocations.”
It doesn’t matter if a limited liability company actually distributes any part of a member’s share – every member still must pay income taxes on the total of his or her distributive share.
Most employed taxpayers have their taxes withheld by their employers, but no taxes are withheld when profits are distributed to limited liability company members.
HOW ARE “ACTIVE” AND “NON-ACTIVE” LLC MEMBERS DEFINED?
Thus, like self-employed taxpayers, LLC members should pay estimated taxes each quarter. A limited liability company member is an “active member” who must pay self-employment taxes if:
1. He or she is active in the business for over five hundred hours during the tax year, or
2. The LLC is in business in the field of engineering, architecture, health, law, actuarial work, accounting, or consulting.
The Internal Revenue Service may not require payment of self-employment taxes from non-active LLC members who do not provide any services or make any company decisions.
Your accountant or business attorney can tell you if your role as a limited liability company member will be classified as active or non-active.
Active LLC members must pay their entire 15.3 percent tax burden, but they may deduct half of the self-employment tax amount from their adjusted gross income.
WHY DO SOME LLCs CHOOSE TO BE TREATED AS CORPORATIONS?
As mentioned previously, a limited liability company may opt to be treated as a corporation for tax purposes.
Since LLC members pay taxes on the LLC’s profits, the option to be treated as a corporation should be considered if the LLC keeps significant profits in the business to foster its growth.
Additionally, this option can help LLC members save on their income taxes.
An LLC may opt for corporate tax treatment by first submitting Form 8832 to the IRS. The LLC then must also submit Form 1120 for each year that it chooses corporate tax treatment.
In many states, LLC members must also pay state income taxes, but as you probably know, there is no state income tax in Florida. That’s one reason Florida is so attractive to new businesses.
WHAT DOES THE STATE OF FLORIDA REQUIRE OF LLCs?
However, to maintain an officially “active” status in this state, limited liability companies must submit an annual business report each year by May 1st to the Florida Department of State.
The annual fee that must be included for LLCs is currently $138.75, but there’s a $400 late fee if the Florida Department of State does not receive the annual report by May 1st.
As a limited liability company member, there are both substantial advantages and significant disadvantages to paying taxes as a sole proprietorship, as a partnership, or as a corporation.
A consultation with an experienced central Florida business attorney can help you decide what will work best for you.
WHY DOES EVERY BUSINESS OWNER NEED A BUSINESS ATTORNEY?
In fact, if you own a business in Florida, you must have a lawyer who provides you with reliable advice, ensures that your legal paperwork is accurate, and represents you in court if necessary.
The government could take your business to court over taxes or a number of other legal matters, but an experienced central Florida business attorney can help you avoid legal trouble – including tax trouble.
HOW CAN A BUSINESS OWNER AVOID TAX AND LEGAL TROUBLES?
The key is understanding the tax and legal issues that you face and then putting the right solutions in place before any legal difficulty emerges. A good business lawyer can help.
If you start up a new business in the state of Florida, or even if you are already a business owner, the reasons to hire a good business attorney might not be entirely clear to you at first.
But a business owner will save both money and time by facing legal and tax issues immediately and straightforwardly.
And the right business lawyer will help you to protect your business from lawsuits, tax trouble, and other legal difficulties. It’s perhaps the best investment that a business owner can make.