So you’ve started your very own company, and based on everything you’ve heard and read about, you decided to create your business as a Limited Liability Company, an LLC. If you’re starting a small business, perhaps as a professional, as a sole proprietor, or single member as they say, you’ve probably made a wise decision for a number of reasons.

Single Member LLC Filing Benefits

One of the main reasons to file as a single member LLC is liability protection. If you follow the rules, and maintain adequate record-keeping an LLC can provide you with important liability protection. LLC’s are also easy to set up, and have some income tax advantages over C Corporations. LLC’s also have some flexibility in determining how they are viewed by the I.R.S. and how they file their income taxes.

The I.R.S. will “disregard” the LLC if only a sole member exists. This means that for income tax reporting purposes, the I.R.S. will effectively “ignore” it and require you to file all income and expense information through your own SSN on your annual 1040, Schedule C.

There are, therefore, no special I.R.S. forms for an LLC. If you startup as an LLC and do not elect to file as a corporation, you will simply file your income and expense information on Schedule C of your personal 1040. The good news here is that you will not be subject to double taxation, as you would if you were a C Corp. C Corporations are taxed at corporate rates, with dividends paid out to owners at their personal rates.

The one catch with filing as an LLC is that you will have to pay self-employment tax. When filing on Schedule C, you will be required to calculate this tax and add it to your 1040.

If you’re the only member of various LLCs, you’ll need to file an individual Schedule C for every business that makes at least $400 of earnings per year.

Self Employment Tax

The self-employment tax for 2023 is 15.3% of net earnings. That rate is the sum of a 12.4% Social Security tax and a 2.9% Medicare tax on net earnings. Self-employment tax is not the same as income tax. For the 2023 tax year, the first $160,200 of earnings is subject to the Social Security portion.

What Happens if Your LLC has a Net Operating Loss?

Net operating losses can flow through to your personal income, as long as you have “sufficient basis” and “active participation” in the LLC.

Active participation means that you “materially participate” in the day to day operations of the company. See I.R.S. Passive Activity and Material Participation Rules here. There are several ways to meet the material participation rules either by meeting the hours requirements which can be a bit complicated or by simply putting more time into the company than anyone else for the tax period. Single member LLC owners of professional service companies should have little trouble meeting this requirement.

Sufficient basis means that you can only deduct losses from your personal income to the extent of the amount of money that you have invested in your company through “paid in capital”. If you’ve only put $250 into the company as paid in capital, you cannot deduct any more than $250 of net operating losses from your personal income. Losses in excess of this amount can only be deducted against business income.

Tax Cuts and Jobs Act

Under this act 20% of pass through income is deductible under certain circumstances if the criteria for Qualified Business Income is met. The full text can be found here.

The Qualified Business Income (QBI) deduction is a tax deduction that allows eligible taxpayers to deduct up to 20% of their QBI, plus 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income ¹². However, the trade or business of performing services as an employee isn’t a trade or business for purposes of section 199A. See more about how the IRS defines “performing services as an employee” at the link above.

For more information on how EAS Income Tax Services can help, click here.