LLC taxes for dummies might be a helpful crash course for anyone looking to start a limited liability company. An LLC is a type of business entity that can be formed by its owners. Limited liability companies can elect for taxation as corporations or partnerships under federal income tax laws. If you're trying to decide which taxation option is right for your company, consult with a business tax professional. 

What Is a Limited Liability Company?

One of the main advantages of an LLC is its flexibility, especially in terms of management authority and profit distribution. For example, an LLC's founders might contribute 10-20 percent of the funds needed to start the business, but they still maintain all authority to run the business. Other investors that contribute to the LLC can share in the business profits, but the distribution structure doesn't have to correlate directly with how much capital each investor puts into the business. The LLC structure offers more flexibility than the corporation business structure, but this flexibility isn't always positive.

All owners of an LLC should enter into an agreement that outlines:

  • How the management responsibilities and authorities will be divided.
  • How the profits will be divided.
  • Responsibilities to contribute additional capital as needed by the business.
  • Right to withdraw capital from the business.

If an LLC doesn't have this type of agreement in place, things could get complicated and ugly. Many businesses end up requiring a legal professional to help resolve these issues. If an LLC's legal structure is too complex, the members might struggle to explain the business to potential lenders, shareholders, and others that could otherwise benefit the company.

Many business owners are starting to realize LLC formation's potential appeal. However, understanding how this business formation can benefit your company can still be confusing. If you have questions about next steps or how to form an LLC, it's best to contact a legal professional with experience in LLC formation.

The Benefits of Limited Liability Companies

Some of the LLC structure's benefits include:

  • Limited personal liability. The LLC members are not personally responsible for business debts or legal action taken against the company. Personal assets, including your home and vehicles, are generally not at risk to pay for business obligations.
  • Business liability protection. If an LLC member is involved in legal action or financial issues on a personal basis, the LLC formation restricts the liquidation of the business to satisfy personal judgments.
  • No ownership restrictions. An LLC can have as many owners, called members, as needed. LLC members can be individuals or other business entities.
  • No management restrictions. The members decide whether the LLC will be managed by the members or by managers.
  • Flexible tax status. LLCs can be taxed one of several ways. It's up to the members to determine what works best for their situation.
  • No separate tax returns. An LLC's default taxation allows each member to report the business losses and profits on their personal tax returns each year.
  • No double taxation. Some business structures are taxed on a corporate level and again on an individual level when profits are distributed. An LLC can have pass-through taxation, which eliminates the corporate-level taxation.
  • Flexible profit distribution. LLC members determine the profit distribution percentage, while other business entities require profits to be distributed based on the percentage of ownership in the company.

Default Rules for LLC Taxation

If an LLC has only one owner, it is disregarded. This might sound strange or confusing, but in this case, disregarding the LLC means all business deductions and income will be reported on the owner's annual personal tax return.

For example, if one person is the sole owner of an LLC that operates an active business or trade, that owner would report all deductions and income on the required “Schedule C Profit or Loss From Sole Proprietorship” form, which is part of the individual tax return form. If a person owns a rental property holding company formed as an LLC, he or she would report business deductions and income on “Schedule E Supplemental Income and Loss,” which is another page on the personal tax return form.

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