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Learn what you need to know about LLC taxation before you decide on which entity type is best for your business. Join Dark Horse CPA, Erik Hegstad, as he takes you through the quick & dirty on LLCs.
hello and welcome. You're tuned into Texas made simple for a speed round on LLCs, which continues our speed round series on entity selection. My name is chase Berkey, CEO of darker CPAs. And I'm joined again by Mr. Eric dad, who is our entity selection guru, Eric, thanks for taking time out of your busy tax season schedule to join us again. Absolutely. Thanks for having me. Hopefully I can live up to the high praise that you've heaped on me. You always do Eric. So my cup of coffee is room temp today, but it still contains the caffeine needed to use the tax out of my brain. Anyway, it looks like you've got your cup ready to go as well. So let's start the clock at five minutes. That sounds like a plan to me. Okay. So as I mentioned, this episode is on LLCs. So Eric, what is an LLC? So an LLC is one of the most popular entity types out there. And it's taxed as a partnership. So similar to a general partnership, limited partnership, limited liability partnership, or any other type of partnership out there. The reason people opt for an LLC over the other types of partnerships is due to the liability protections, especially when compared to a general partnership, LLC members are only liable for the debts of the business, to the extent of their investment. Uh, yes. So how about from the tax side of things, an LLC could later elect to become an Corp? Absolutely. If you're trying to decide between being an LLC or escort, you should just form an LLC now because you can make the selection for your LLC later on down the road. And oftentimes I'll advise clients to do exactly that so that we can make a determination as we get further into the year and can see how the numbers are shaking out, whether it would be more advantageous to be an LLC or escort God, I love the flexibility there, but let's assume they decide to remain taxed as a partnership instead of as an S Corp. What does this look like? So there are multiple members. It will look a bit like an escort and that you'll get a K one. Unlike an escort. However, all of your K one income will be subject to self-employment tax. If you're the only owner, then it will look more like a sole proprietorship. Since the IRS does not recognize a single member LLC, to be separate from the proprietor. So you'd report your income and deductions on your personal tax return via schedule C in that case, but they would still get the liability protections of an LLC one day. They do, but if they get audited, both the LLC and the personal tax return are going to be audited because it's all reported on the same tax return. Right? Just another nuance to account for, with entity selection. Can you explain to our listeners what pass through income is? Yep. So as a member of an LLC, you can't pay yourself a W2 wage. People do it, but the IRS specifically prohibits it. So a member of an LLC gets what's called guaranteed payments instead of a W2 salary. This income is subject to self-employment tax and the amount that you're paid in cash generally anyway, is what you're taxed on. Pass through income. On the other hand is the taxable income of the business that is passed through to you as if you had. Gotcha. So can you give us an example on this. Yep. So let's say the LLC had a hundred thousand in revenue and 20,000 of deductible expenses and thus had 80,000 of taxable income. If you own 100% of the business. Then you will be taxed as if you yourself had earned $80,000, regardless of whether you took any money out of the business or not. If you own 50% of the business, then you would be taxed on half of the 80,000. So you'd have to report 40,000 of income. Yep. So a lot of new business owners get tripped up on this because by the time you file your tax return, you don't always have the cash on hand that would correspond to the income that you're being taxed on. Exactly. It's a bit of a moving target because you have things like depreciation and other types of expenses that make it. So there's a disparity between the net cash gained or lost versus the taxable income or loss of the business. So what happens when an owner takes money out of the LLC in the form of a distribution? Well, if it's not a guaranteed payment, then it's not taxable because you're already paying tax on the income of the business. It just reduces the amount of after tax dollars, you can pull out of the business. This is what is referred to as your basis. If a distribution causes your basis to go below zero, because you've taken out more from the business than you've been taxed on, then you have to pay tax on the amount of the distribution that took you below zero. Well said anything else that we should know about LLCs because of the pass through income concept that I touched on LLCs do not pay taxes to the IRS since they pay it at the individual level, they do. However often pay taxes to their state LLCs can distribute money. However, they see fit as long as it's in accordance with their operating agreement. Unlike escorts that have to make proportionate distributions. They also don't have to do the corporate formalities of meetings and minutes Eric killing the game. And I think we, for real made it under the five minute Mark this time. So to our listeners, if you have any questions on what type of business you should create, or if you just need a new CPA and you like what you're hearing from Eric, you can email him at Eric at dark horse dot CPA. Once again, that's Eric with a K at dark horse dot CPA. So as always, we'd like to thank you for tuning into TMS, or if you're not into the whole brevity thing, taxes made simple because there's TMI and then there's TMS.
