LLC Pass Through: Everything You Need to Know
An LLC pass through refers to the pass-through characteristic of this type of business entity when it comes to taxation. 3 min read
An LLC pass through refers to the pass-through characteristic of this type of business entity when it comes to taxation. The profits and losses of a Limited Liability Company (LLC) pass through the company and on to the members (owners) of the business.
What Is an LLC?
Any profits or losses for the company pass on to the members, so business income is actually taxed through the personal income tax returns of the members, not the company itself.
It is a bit harder to form an LLC than it is a sole proprietorship or partnership, but it's much easier than a corporation. LLCs are becoming the most popular business structure in the United States today.
Main Features of an LLC
The members, also known as the owners, of an LLC are protected from liabilities if the business goes under or has any legal issues, just like the shareholders in a corporation. In the case that an LLC goes into debt with a credit company or supplier, that company cannot go after the personal assets of any of the members. The only thing the members could possibly lose in a problem with the LLC is their capital investment. This is what the "limited liability" refers to in the business structure's name.
- The member injures another person.
- The member guarantees payment on a bank or business loan personally and then the company defaults.
- The member does not pay tax withholdings from payroll.
- The member participates in fraud or illegal or dangerous activities that lead to issues for the company or harm another individual.
- The member fails to keep an appropriate separation between the company and their personal interests or actions.
An LLC can be dissolved if it is found that it is not being handled as a separate legal entity. In order to avoid having a court decide that the company members have not kept appropriate separation between company affairs and personal affairs, owners must:
- Conduct all business within legal bounds and fairly to customers.
- Be honest about company finances and other facts with clients, vendors, and anyone else interacting professionally with the company.
- Make sure that the company has the necessary funds to properly do business.
- Keep LLC business and personal business completely separated, especially bank accounts and all finances.
- Obtain an EIN (Employer Identification Number) for the LLC.
- Formulate an Operating Agreement.
Also, insurance companies offer liability policies to business owners as an added protection for their personal assets. These are ideal for services that include risks like massage therapy, snowboarding lessons, and others.
If the limited liability status of an LLC is overruled by a court, liability insurance can still provide coverage.
Protection is only granted in cases of lawsuits and the like, but LLCs can't be protected from paying off business debts.
Income Taxes for LCC Members
As a pass-through type of business structure, an LLC isn't required to pay federal income tax. Certain states do require LLCs to pay annual state business taxes, however.
In the eyes of the IRS, a multi-member LLC is seen as a partnership unless it has opted for a different taxation status. Owners of the LLC will pay income taxes on the profits they acquire from the company according to their shares with a Schedule E form attached to their personal tax returns.
The amount allotted for each member of the LLC should be spelled out in the operating agreement. These distributive shares can be according to the principle interest each member took on as the company was formed, or they can reflect the amount of management responsibilities of the members.
Single-member LLCs are viewed as disregarded entities; therefore, the owner is required to report the profits and losses of the company on their Schedule C and 1040 tax returns each year. If any money is left in the company's account, income tax must be paid for that money.
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