The Tax ABC’s of LLCs
In our line of work, one of the most frequently asked questions is, "What happens if I become an LLC?" This inquiry often centers around understanding the tax implications of incorporating a business into an LLC, and it is an incredibly common question! Typically, LLCs are extremely easy to form and inexpensive to maintain relative to other legal formation options for a business entity. Because of the added liability protection afforded with forming an LLC, forming an LLC is very common in starting a small business.
For those who are starting a small business and have never been self-employed in the past, taxes associated with small business ownership can be daunting. Many business owners who are already confused about their potential tax liability, assume that forming an LLC will automatically change how their taxes are calculated, reported, or paid.
The good news for those uncertain owners - the act of forming an LLC does not change how the IRS taxes the income generated from the business activity.
While certain states might have additional reporting or other fee requirements for LLCs, and the LLC formation might open the business owner up to additional industry-specific licensing requirements, etc.,
as far as the IRS is concerned, LLCs are not taxed as corporations unless specifically elected.
The specific phrase the IRS uses for this non-recognition of the LLC, is the term “disregarded entity”. Business owners should educate themselves as to any state-specific regulations and industry-specific nuances, but as far as IRS taxation is concerned, the business income & expenses of a sole proprietor-turned-LLC continue to be reported on Schedule C of the 1040 tax return. Unless a special election is made by the business owner, the reporting methodology & tax treatment of the business activity remain the same.
Grasping the ‘disregarded entity’ concept can empower a business owner to keep taking the next right step in the evolution of the business, while relieving any concern over drastic changes in tax liability or reporting.
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