Tax Aspects of Limited Liability Companies (LLC)

Limited Liability Companies

 

This article is about a relatively new form of conducting a business that combines the advantages of a partnership and a corporation. In the last few years, states have passed statutes allowing the creation of limited liability companies (or LLCs). You may have heard something about LLCs. Here is what they can mean for you:

If you are already doing business as one of the other entities, it may make sense to consider converting to an LLC.

  • Electing to be an “S” corporation avoids double taxation. But “S” corporations have many restrictions as to the number and type of shareholders, classes of stock, ownership of subsidiaries, etc.
  • A business can be conducted in a number of forms, such as a partnership, a regular corporation, or an “S” corporation. Doing business as a partnership has many tax advantages. Income is taxed only once, and there is great flexibility in how income and deductions are passed through to the partners. But the partners’ assets are put at risk, since each general partner is personally liable for the partnership debts and obligations.
  • Corporations don’t have the liability problem, since shareholders aren’t responsible for debts of the corporation. However, a corporation’s income may be taxed twice, once when the corporation earns it and once when it is distributed to the shareholders in the form of dividends.

The limited liability company offers a way out of this dilemma. An LLC is owned by investors known as members. It is managed either by the members themselves or by designated managers. Like shareholders of a corporation, the members’ liability is limited to the amount of their investment. Also, IRS generally treats LLCs that are owned by more than one person as partnerships for tax purposes. LLCs that are owned by one person are disregarded for tax purposes, with the result that the income of the LLC is taxed to the owner directly, without any entity level tax.

Is Your Worker an Independent Contractor or an Employee?

There is no set definition of the term, “employee.” While determining whether an employee is an independent contractor or a regular employee is crucial factual information, the label is also a complex one.  In the event that a worker is an employee of a company, the employer is required to pay FICA taxes on the employee’s wages, pay FUTA tax, and typically provide the employee with the same fringe benefits as the company’s other employees. In addition to this, the state tax obligations apply to an employee as well.  However, independent contractors do not carry the same requirements; the company is only required to send a 1099-MISC form to the independent contractor that shows his or her wages, provided that the total is over $600.

An independent contractor is generally someone is not controlled by the company regarding his job’s nature and procedure.  If the company reserves the right to control and direct his job, as well as his job’s procedures, then the person is generally considered an employee. These terms and definitions originate from court cases, not tax code, hence the complexity.

Section 530 of the ’78 Revenue Act, which is different from the Internal Revenue Code, relieves employers from employment tax liabilities if they have mistakenly classified workers as independent contractors.  Section 530 only applies under the following conditions: the employer had a “reasonable basis” for not treating the worker as an employee, company filed all federal returns consistently with its treatment of a worker as an independent contractor and treated all similarly situated workers as independent contractors as well.  The “reasonable basis” can be used if the employer has traditionally treated similar workers as independent contractors for a significant period of the employer’s industry. This section does not apply to certain types of technical services workers.

Individuals who are specifically identified by the tax code as being employees, or “statutory employees,” are treated as employees for social security tax purposes. This applies even if they aren’t subject to an employer’s direction and control, or, considered “employees” by common-law rules.  Home workers, full-time traveling or city salespeople, agent and commission drivers, and life insurance salespeople are included as statutory employees.  For non-FICA purposes, statutory employees may or may not be employees; however, corporate officers are statutory employees for all purposes.

Those who are specifically identified by tax code as being non-employees, or statutory independent contractors, are not considered employees for the purposes of FUTA or FICA, income tax rules in general, or wage withholding. These workers are certain direct sellers and qualified real estate agents.

Corporate directors are examples of individuals subject to special rules, due to their occupations or identities.  Corporate directors are treated as self-employed persons because of their capacity as directors of a corporation. Partners of an enterprise organized corporation are treated in the same fashion.

You may refer to Form SS-8 when asking the IRS to decide which worker is an employee or independent contractor, under certain circumstances.

Take care to properly classify your workers as employees or independent contractors.

 

A Certified Public Accounting firm, Baker and Company, PC is located near downtown Dallas. Ford Baker, owner, has been a CPA serving the DFW Metroplex, Plano, Collin County, and all of North Texas since 1987. The firm has many professionals ready to help small businesses and individuals on taxation issues, tax preparation, small business accounting using QuickBooks, PeachTree, and a variety of other solutions and/or assistance with financial statement preparation and reporting to lenders. For more information about this article or what we can do to help you, please feel free to contact our office at 214.827.9118 or visit our website at www.bakerandcompany.com.