1. What Is an LLC?
2. Understanding Corporations, Partnerships, and Sole Proprietorships
3. Filing Taxes as a Single-Member LLC
4. Alternatives to Single-Member LLCs

A single member LLC with employees is a business entity with a single owner that's legally recognized by the state. However, the IRS and courts have ruled that a single-member LLC cannot have an owner that is both an employee and a partner, meaning this type of entity is not legally permissible.

What Is an LLC?

A limited liability company (LLC) is a type of business that provides the flexibility of a partnership for profit allocation and operational purposes but offers the legal limited liability of a corporation. In the case of a single-member LLC, it is not a partnership, but a sole proprietorship.

LLCs are common choices for most businesses offering professional services. In some cases, such as law firms, the structure may be called a limited liability partnership (LLP) rather than an LLC.

Understanding Corporations, Partnerships, and Sole Proprietorships

LLCs are not recognized on the federal level. Rather, they are a state creation. This means that the IRS does not have special tax classifications for LLCs. Instead, they are considered a:

Multi-member LLCs can be either corporations or partnerships, while single-member LLCs are either a corporation or a sole proprietorship (also known as a disregarded entity).

For either a multi-member LLC or single-member LLC to become a corporation, they will need to file Form 8832 and choose corporation status. If a multi-member LLC does not do this, the IRS automatically classifies them as a partnership. For single-member LLCs that skip this step, they'll be designated as a disregarded entity.

Filing Taxes as a Single-Member LLC

Filing taxes in a single-member LLC that's a disregarded entity can be confusing. However, Notice 99-6 provides two options for these types of businesses:

  • Paying taxes using the employer identification number (EIN) and name of the single member.
  • Paying taxes using the EIN and name of the LLC.

Even if the owner of the LLC decides to file taxes using the LLC's name and EIN, the owner will still bear personal responsibility for accurately reporting and paying employment taxes for the LLC.

It's easy to get an EIN for your LLC. All you have to do is file Form SS-4, Application for Employer Identification Number. When filling out Form SS-4, you'll need to check box 13 if you have or expect to have employees. This guarantees you'll be issued an EIN if you don't already have one.

Keep in mind that if your single-member LLC is a disregarded entity, you don't need a business EIN when filing your federal taxes. Instead, you should pay using your personal name and EIN. If you have created a business EIN for employment tax requirements, state law requirements, or banking documents, you'll need to fill out the "Other" box on Line 8 of your federal tax return. In this box, write "Disregarded Entity — Sole Proprietorship."

If you have employment tax returns to file, you should not use your personal EIN when filing. Using your personal EIN interchangeably with your LLC's EIN could cause a lot of problems, requiring a lot of back and forth between you and the IRS to correct.

If you aren't sure which number to use, refer to Notice 99-6. This defines the rules on switching back and forth between your individual and LLC EIN.

Regardless of which option you decide on, all wages paid by your LLC must be reported on a Schedule C as employee expenses. Additionally, you'll need to submit the W-2 you received from your LLC on your personal tax return.

Alternatives to Single-Member LLCs

Many LLCs want to consider themselves as employees so they can have local, state, and federal taxes withheld in their paychecks to avoid a bigger burden come tax time. However, this often leads to LLC owners incorrectly reporting compensation on a W-2 at the end of the year, while their residual profit is reported on a K-1.

The simple way to avoid this issue is to elect out of the default and switch to an S corporation election. This lets owners receive flow-through treatment for their profits.

Another slightly more complicated option is to create a tiered partnership. In this partnership, the partner will own the upper tier of the partnership. However, they will be employed by a lower tier of the partnership in which they hold no interest.

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