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LLC is a flexible business entity that offers limited liability protection to its owners.
Small businesses love LLC.
And it's not a surprise.
LLC makes it super easy for business owners to grow their business and protect their personal assets at the same time.
In this guide, we'll cover what an LLC is and whether it is right for your business.
LLC is a business entity which is like a hybrid between a corporation and a sole proprietorship.It gives the owners protection from personal liability (like a corporation) and offers pass-through taxation (like a sole proprietorship). Best of both worlds!
An LLC can have single or multiple owners. Those owners are referred to as members of the LLC.
In most states, anybody can be an LLC owner, including: individuals, corporations, partnerships, other LLCs, foreigners or even foreign entities.
And you can have only one member owning the entire LLC or multiple members sharing the ownership.
But, unlike a corporation, LLC can't issue stock to its members. The ownership is divided based on what members have agreed on in the LLC's operating agreement.
For example, you could have 3 members at 33-33-33 split or 70-20-10 or whatever you agree on.
Although it's not a strict rule to have an operating agreement, it's always a good practice to have one.
Now that we have some idea of what an LLC is, let's see what's special about it.
There are 3 broad types of LLC: Single Member LLC, Multi Member LLC and LLC elected to be treated as a corporation.
Your LLC will fall under one of these, depending on the number of members and also whether you have requested IRS for a change in tax classification.
LLC usually pays 3 types of taxes: Income tax, payroll tax and franchise tax.
They are paid to the federal government and state agencies.
All taxes are not paid the same way.
Depending on the type of LLC and how members are paid, tax treatments can vary.
In single and multi member LLC, the LLC doesn't pay income taxes; the members pay them individually. That's how pass-through taxation works. The entire LLC income is transferred to the members and is reflected on their personal tax returns.
For an LLC elected as a corporation, things are slightly different. Here, the LLC pays corporate income tax directly. It's not transferred to the members.
Social Security tax, Medicare taxes and unemployment insurance are commonly referred to as 'payroll taxes'. Half of this tax amount is collected from the employee's paycheck. And the other half is contributed by the LLC.
Since the members are considered 'self employed', they have to pay self employment tax (which is kind of another name for payroll taxes). Since there is no paycheck for a member, this tax amount is collected in proportion to the share of profits.
If a member isn't actively part of the operations, then he/she does not have to pay self employment taxes. Regulations around this are slightly complicated, though.
Most states charge an annual fee from LLC, often called as "franchise taxes", "renewal fees" or "annual registration fees". In certain states, this is the only state income tax. This really depends on how the state calculates it. Most states have a fixed fee between $50 - $800. For example, Delaware, charges $300 and Wyoming charges $50.
Excise taxes are typically imposed on manufacturers and retailers of goods and services. Not very common, however still important to many types of businesses.
If you thought, you could pay all the taxes in one shot at the end of the year, sorry to break it to you; IRS won't buy it.
You will have to estimate the annual income for each member ahead of time and split it into 4 quarterly payments. This is referred to as estimated taxes.
So, should all LLCs pay taxes this way?
If you estimate to pay more than $1000 amount annually, you'll have to split it into 4 and be paid in April, June, September and January.
IRS is pretty serious about this.
They charge a penalty if you fail to pay an instalment or pay it late.
So, keep this in mind.
Also, if you're just starting up or if you haven't earned any income during a quarter, you can skip an instalment entirely.
These are some of the most common tax rates applicable to an LLC.
Of course, some of these numbers will vary depending on your situation.
Take this only as an approximate figure.
Non-residents don't have to pay any income tax in United States. Therefore, your LLC essentially doesn't need to pay any income tax. If you have an employee(or any other dependent agent) who is dependent on your income in the US, you have to pay payroll taxes
Non resident aliens are not subject to self employment taxes
A very popular topic: paying yourself.
All your effort, sweat and time put into growing your business.
Now, it's time to reward yourself.
There are mainly 3 ways of taking money out of an LLC: Making a member's draw, taking a salary or through dividends.
The last two methods are almost exclusively meant for LLCs elected as a corporation.
When your LLC is not elected to be treated as a corporation, you can withdraw money from your LLC's account in proportion to your share of LLC profits.
This is known as a member's draw.
This is how members typically get paid from an LLC, when they are not an employee.
And when you make a member's draw, your LLC doesn't have to withhold tax for social security and medicare taxes. Because it's not a paycheck. It's your 'share' of profits.
As a member, you'll have to pay taxes on this share of profits separately.
It's important to plan your members' draw. You don't want your LLC to run out of working capital.
For an LLC elected as a corporation, taking a salary is almost always the best method of getting paid if you want to avoid double taxation.
Also, it's kinda legally required to consider shareholders as employees.
This doesn't mean you take an exorbitantly large paycheck, though. There are checks and balances.
The salary amount has to be on par with industry standards.
And it shouldn't look like you are evading tax. Talk to your CPA about this.
On the other hand, single and multi member LLC members cannot be hired as the employees. They will HAVE to take a member's draw.
For LLCs that are taxed as a corporation, members can be paid dividends on the company profits.
But dividends are not tax deductibles. Meaning: it is subject to double taxation though.
The income is taxed at corporate tax rate of 21% first, then up at individual tax rate at 23.8% on the dividends.
A single member US LLC can be owned by a foreign entity or a founder. You can take member's draw without having to pay any income tax to US
There are different types of costs involved in an LLC.
Costs depend on a lot of factors: state of formation, nature of business, etc.
Following is a list of some of the common costs that you might incur in the initial days.
One of the main reasons to register a business is to be able to hire employees.
LLC is an ideal entity for this.
It is simple enough for you to start hiring and complex enough to protect you in case of employee lawsuits.
You can hire employees whether it's a single member or a multi member LLC.
It comes with a few responsibilities, though.
If a non resident-owned LLC has an employee living the US, you would have to start paying payroll taxes. If you wish to avoid having to payroll taxes, you can hire independent contractors or freelancers. The law asks you to pay taxes if you have a 'dependent agent' in the US. How to establish 'dependence' is a slightly complicated area. It is best to speak with a lawyer regarding this.
As a rule of thumb, if you have a physical office or an employee located in the US, it is best to form your LLC in that state.
If you have an e-commerce store that you manage online, but you stay in Texas → Form your LLC in Texas.
If you form your LLC in Delaware, but ended up having a store in California, you'll have to file your LLC as a 'foreign LLC' in California as well. So, pick your home state if you're a resident.
If you don't have any employees or a physical office in the US, you could choose either Delaware or Wyoming to form your LLC. It is because these two states are very business-friendly and have the best legal structure in place.
Here are 6 steps to give you a basic understanding of formation.
If you wanna know more about the exact formation steps, read our step-by-step guide below
Once your business is up and running, you'll come across situations where you may want to change your tax classification or completely change your business entity.
You may want to reduce your taxes. Or accommodate a new member.
Whatever your reason is, let us see some of the conversions.
Maybe, LLC isn't the right entity for you. Maybe it is a C-Corp. Only way to find out is to directly compare them all.
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