Tax Implications of a Single Member LLC

So you’ve got a brilliant idea for a business, or you have learned the ropes long enough within a particular industry to venture off and open up shop. Before taking the leap from employee to employer, there are significant tax implications which you should be aware of.

Your first big decision is what entity classification to use for the start of your own business. The most common choices are sole proprietorship, single member LLC, partnership and S-Corporation. Different tax entities provide different benefits, so be sure to consult with an experienced accountant or adviser when making this decision.

Assuming you will want some legal protection for your personal assets and you will be the sole owner of the business, it’s likely that a single member LLC would be most appropriate. As an LLC, you can ultimately elect tax treatment as an S-Corporation in the future if it is more beneficial. Alternatively, you cannot initially setup your business as an S-Corporation and revert back to a single member LLC.

For the purpose of this article, we will focus on the tax implications of setting up your business as a single member LLC.

If you have setup your business as a single member LLC, you do not file a separate business tax return. The income and expenses of your business are reported on your individual income tax return. In addition, balance sheet items of the business such as cash balances, asset totals, business liabilities and loan balances are not reported on your income tax return, although you should still maintain your own accurate records.

Previously, as an employee, your paychecks are paid to you net of taxes already withheld. At year-end you pay tax on your gross wages and apply your withholding against your liability. In many cases, you may have a refund which essentially means that too much was withheld from your paycheck during the year.

As the owner of a single member LLC, you cannot be on payroll. You are free to draw money out of your business account anytime it is available for you to do so. You pay tax annually on the year-end profit of your business, regardless of what you take out personally. For instance, if you had $75,000 of profit for the year but only drew out $50,000 from the business account, you pay tax on $75,000.

Because you do not have any money being automatically withheld and paid for taxes, you need to closely monitor the profitability of your business. If your business has profit, it is often recommended that you make estimated tax payments during the year in order to avoid penalties and paying a potentially large lump-sum with the filing of your individual income tax return.
In addition, federal payroll taxes such as social security and Medicare which are typically withheld from payroll checks must now be paid in the form of self-employment taxes on your individual income tax return, in addition to income taxes which everyone pays.

While starting a business can be very gratifying and rewarding, one must understand the tax implications which will come as a result of the changes and be prepared to handle these new responsibilities.