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LLC Questions, taxing, salary, taking draws, etc...

 
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dirtysparks
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PostPosted: Dec 18, 2006 10:09 am    Post subject: LLC Questions, taxing, salary, taking draws, etc... Reply with quote

I'm going to file my Article of Organization early 2007 and am looking for a bit of information.

A bit of background:
I work for the state as a Systems Administrator and do fine here but have the potential for much more. I've done work for small businesses around town who all mention they can't afford to contract large IT companies. The LLC will be a side job for me for starters, so I would be the only employee. I've already got the name, equipment, website, and office(home for now) figured out.

After the Articles of Organization are filed, I think I'm on my way. I've read a few different options for taxing and compensation. Most of the money made in this venture will go straight back into the company as I'll be keeping my fulltime job. I'm sure there will be a point in time where the company has some money that I'll want to take out so this is where I'm concerned.

The IRS claims that you need to be paid a *reasonable* amount which is pretty much left up in the air. I've read that some take a modest salary and pay the rest in distributions which I understand are profits passed onto you as a shareholder. Salary is subject to employment taxes, but distributions are not.

I don't understand where the taxation comes in on an LLC. Is the company taxed at all for their earnings or does all the taxation come out when the officer(s) take salary? As I understand, taxes are paid by the individual rather than the corporation. Perhaps I misunderstand how LLC's are taxed but how can you write off business expenses if the company isn't being taxed?

I'll most likely talk to an accountant first, but I'll want to keep the books myself. Just trying to get my feet wet. Thanks!
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brew
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PostPosted: Dec 19, 2006 6:30 am    Post subject: Reply with quote

You're off on how LLC's work. An LLC is basically an extension of you personally and is treated one of two ways.

If you are the sole owner, the income and expenses of the LLC are included on a Schedule C on your personal return. The taxable income at the end of the year is taxed at your individual rate plus you pay 15.3% self employment tax. You can't take a salary out (per se), you can only take draws. This has no effect on taxable income. Basically instead of writing yourself a payroll check and withholding taxes, you just write yourself a check for whatever you want to draw out of the company. Again, this will have no effect on taxable income because it is not considered an expense.

If their are multiple owners, the only difference is that you will have to file a 1065 partnership return and you will get a K-1 for your portion of the earnings. That portion will go on your tax return and you will pay tax at your regular rate plus the self employment tax. Paying yourself is treated virtually the same except for one caveat. When any of the owners pay themselves, it is treated as an expense so that overall net income is lower. Then it is added back on the owners K-1 as guaranteed payments and he is taxed on it. For example: 2 owners - $100,000 NI after $50,000 payment to #1 and $25,000 payment to #2. K-1 would show $50,000 in NI and $50,000 GP for #1 and $50,000 in NI and $25,000 GP for #2. #1 would pay income tax and self-employment tax on $100,000 and #2 would pay on $75,000.

Depending on what state you are in there will also be state income tax and franchise tax implications for setting up an LLC as well as annual fees.

Sometimes if you are looking at a single-member LLC and you can mitigate your risk with insurance, you can be better off just staying a sole proprietorship. It all depends on the inherent risk in your business and whether you can purchase insurance coverage to mitigate the risk for less than the increased taxes you will pay.
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dirtysparks
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PostPosted: Dec 19, 2006 9:02 am    Post subject: Reply with quote

15.3% self employment tax on top? Damn.

So with the below information, I'm in the 25% category. I pay my normal income tax and file a class C along with it. Does the income from the class C add on to my current salary and push me over into the next tax bracket or is that considered a seperate entity?

Assuming this is all taxable income, say I make 50 grand in my first year (yeah right), thats $9165 for taxes. 4090 + 5075(25% of 20300)

I add on another 15% on to that for self employment tax? I'm guessing that's after the 9165 so 50000 - 9165 = 40835. 40835 * 15% = 6125.25.

So total tax of 6125.25(self-employment tax) + 9165(individual rate) = $15290.25

I keep approx. $34710 in the business out of 50K and can take a draw on that whenever I want.

Of course this is all assuming the schedule C and my personal returns are treated seperately. If not that would put me into the next bracket and I'll have to pay more in taxes.

If the above is wrong, I basically take my regular salary with my FT job and dump the earnings from the LLC on top. So say I make 50K at my FT job pretax and 50K taxable earning at the LLC. Then I'd get bumped into the 28% tax bracket and pay a self-employment tax on just the LLC earnings?

I have read that an LLC can file as an S-Corp but I don't fully understand this or if there are any benefits. I guess I'm off to study up on keeping a sole proprietorship Wink
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dirtysparks
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PostPosted: Dec 19, 2006 9:27 am    Post subject: Reply with quote

I was just reading here...
http://www.businessknowhow.com/startup/llc-scorp.htm

...that there is an annual franchise tax also. $800 due 75 days after formation and every year after that as well. What happens when your company doesn't turn a profit for the first few years?
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brew
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PostPosted: Dec 19, 2006 9:33 am    Post subject: Reply with quote

Quote:
If the above is wrong, I basically take my regular salary with my FT job and dump the earnings from the LLC on top. So say I make 50K at my FT job pretax and 50K taxable earning at the LLC. Then I'd get bumped into the 28% tax bracket and pay a self-employment tax on just the LLC earnings?


^^^ is the way it would work. You would pay whatever the tax would be on the $100K plus 15.3% self employment tax on the LLC earnings. You also get an adjustment to income for 1/2 the SEP tax so in your case above you would show income of $100,000 an adjustment of $3,825 for taxable income of $96,175. That would be taxed at the single (I assume) rate and then you would add on $7,650 in self-employment tax.

You can buy equipment, vehicles, etc. to help bring the LLC's income down as well as some other tax planning methods. You can make contributions into some retirement plans that are available if you have self-employed income. This will bring your taxable income down, but will not affect self-employment tax. If you pay your own health insurance you can deduct the premiums as long as you have self-employment income. There are deductions that having self employment income will open you up to, that are not available to people with W-2 wages.

Quote:
I have read that an LLC can file as an S-Corp but I don't fully understand this or if there are any benefits. I guess I'm off to study up on keeping a sole proprietorship


You have to incorporate as an S Corp to file as an S Corp. The major difference between the S and the LLC (at the federal tax level) is that you can treat yourself as an employee and withhold taxes on checks to you. You are still paying the taxes, it is just coming directly out of the company. The net income would pass through to you on a K-1 and would be taxed in addition to your normal income, but you would generally not owe self-employment tax. However, this is sometimes offset by states because some states do not tax the earnings of an LLC but will tax the earnings of an S Corp. There are additional expenses involved with an S Corp that are not their with an LLC also.

As far as the sole proprietorship goes, for federal tax purposes it is no different that a single member LLC. The differences come up with liability and at the state tax level.

I don't know what state you live in, so all of this is directly tied to the federal tax level. Different states treat LLC's, S Corp's, etc. differently. For instance if you were in TN, the only additional taxes you would pay at the state level to be an LLC instead of a sole proprietorship would be franchise tax on the value of the business and a $300 annual fee. So in TN it is generally better to be an LLC than a sole proprietorship. However, this varies state by state.


Last edited by brew on Dec 19, 2006 9:40 am; edited 1 time in total
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brew
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PostPosted: Dec 19, 2006 9:37 am    Post subject: Reply with quote

Quote:
that there is an annual franchise tax also. $800 due 75 days after formation and every year after that as well. What happens when your company doesn't turn a profit for the first few years?


That is set by state. That article is from CA, but TN has a $100 minimum franchise and a $300 annual fee. KY has something like a $35 minimum franchise tax and a nominal annual fee.
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dirtysparks
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PostPosted: Dec 19, 2006 10:10 am    Post subject: Reply with quote

Well, I just called our tax commisioner and there is no franchise tax for North Dakota. She mentioned to me that the self employment tax is paid quarterly. Alternativerly I can have more withheld out of my regular salary and avoid the quarterly payments.

So for every dollar the LLC makes, I should expect to pay around 15% quarterly to state and federal and at the end of the year I can deduct 1/2 of the total amount from my taxable income between my regular job and LLC profits.

Hopefully, I can still file by myself with turbotax. Laughing

Thanks for the great info brew!

Oh, by the way, here's the link that gave me the idea that an LLC can elect to be taxed by an S or C corp. 4th bullet point down.

http://biztaxlaw.about.com/od/taxforms/a/llc_forms.htm
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brew
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PostPosted: Dec 19, 2006 11:21 am    Post subject: Reply with quote

Quote:
Oh, by the way, here's the link that gave me the idea that an LLC can elect to be taxed by an S or C corp. 4th bullet point down.


That is true, but it makes very little sense to do it this way. If you want to be taxed as an S corp, then set up an S corp. The pros/cons between setting up an S corp or LLC are generally tax reasons. There are things to gain/lose when selling the business, passing it on, etc. between the two, but you lose the leeway if you set up an LLC and tax it as an S Corp. For federal purposes it is then recognized as an S Corp.

Quote:
Well, I just called our tax commisioner and there is no franchise tax for North Dakota. She mentioned to me that the self employment tax is paid quarterly. Alternativerly I can have more withheld out of my regular salary and avoid the quarterly payments.

So for every dollar the LLC makes, I should expect to pay around 15% quarterly to state and federal and at the end of the year I can deduct 1/2 of the total amount from my taxable income between my regular job and LLC profits.


There is not a franchise tax in ND, so all tax implications are going to be the same for federal and state. It is going to be solely based on income.

The second part is off. The way it works is that the total additional tax is paid in quarterly installments, not just the self employment portion. Here is an example of what I mean:

Let's assume the same circumstances as above and that you normally have $9,000 withheld on your W-2:
Prior year
Income from job..............................$50,000
Standard deduction and exemption...(8,200)
Taxable income.................................41,800
Tax.....................................................7,115
Withheld.............................................9,000
Refund................................................1,885

Current year
Income from job................................50,000
Income from LLC...............................50,000
1/2 self-employment tax.....................(3,825)
Standard deduction and exemption...(8,200)
Taxable income.................................87,975
Tax....................................................19,140
Self-employment tax...........................7,650
Total tax due.....................................26,790
Withheld.............................................9,000
Due....................................................17,790

The additional tax of $17,790 would have to have been paid to the IRS in quarterly deposits of $4,448 during the year to avoid penalty. Your state income taxes would be figured the same way except for using your state rates and there would be no self-employment tax.

Now the key is tax planning to bring your income down as much as possible. You can contribute to a SEP plan up to 20% of self employed earnings less self-employment tax. So in the above example you could contribute about $8,500 to the retirement plan and that $8,500 would be added to the $3,825 adjustment above which would bring taxable income down more. Health insurance premiums also would go on that line which would bring it down more. In essence the govt pays for part of the contributions.

See there are all sorts of issues out there that can affect tax. With proper planning, you can completely change what a tax return will look like. If you have more questions, post them and I will see if I can help.

Quote:
Hopefully, I can still file by myself with turbotax.


Whatever floats your boat. Just remember that we aren't all as expensive as what you think.
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dirtysparks
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PostPosted: Dec 19, 2006 11:56 am    Post subject: Reply with quote

Forgive me for being ignorant, but I'll be paying in my tax (llc - job withholding) quarterly? I suppose I need to anticipate how much will be withheld from the regular job, look at my anticipated tax for the LLC quarterly, subtract the two and I've got my quartely estmate.

Do you just anticipate what your deductions for the year will be also? My personal deductions are pretty simple - house & college. The business deductions will add up much quicker I'm sure. I suppose if you overpay on your quarterlys, you'll simply get a refund at the end of the year.

And the turbotax thing was a joke, I'll most likely need to hire an accountant to check over my work for the first year.

Great info.
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brew
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PostPosted: Dec 19, 2006 12:04 pm    Post subject: Reply with quote

Quote:
Forgive me for being ignorant, but I'll be paying in my tax (llc - job withholding) quarterly? I suppose I need to anticipate how much will be withheld from the regular job, look at my anticipated tax for the LLC quarterly, subtract the two and I've got my quartely estmate.


That is correct, but above you said about 15% a quarter on the LLC earnings. It would actually be your income tax rate (25% assuming you stay in that bracket) + your self employment tax (15.3%) that would make up the tax on the LLC.

One other thing, the first year it doesn't matter. You do not have to make estimated tax payments as long as what is withheld at your normal job equals or exceeds what was withheld last year. You may have a large tax bill at the end of the year, but you will not owe penalties and interest.
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