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How to Avoid Single Member LLC Tax Errors

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A limited liability company (LLC) is created by many taxpayers to receive more protection from the federal government. A single member LLC is the same concept as any other LLC, only that it is limited to a single member or employee of the company.

There are advantages and disadvantages to creating a limited liability company when it comes to taxes. How do you avoid single member LLC tax errors? Let’s examine the subject in more detail.

Understanding a Single Member LLC

A single member limited liability company (LLC) is a registered business with only one owner/member. Limited liability companies may have more than one member, yet in this article, we only focus on single member LLCs.

Limited liability companies can elect to get treated like a corporation, but it’s rare. Instead, most single member LLCs have all of the income and expenses related to the enterprise reported on a Schedule C attached to IRS Form 1040.

This is different from an LLC with more than one member or corporation, where the single member’s income and expenses are aggregated with the other income and expenses of the partnership or corporation reported on the tax return of the entity.

Advantages of Single Member LLCs

Several self-employed individuals elect to create a limited liability company (LLC) to receive more legal protection. 

A single member LLC acts as a shield that protects your assets from the liabilities associated with the business conducted by the company. A single member LLC also receives protection from debts related to the company.

Single member LLCs also save money and time during tax season. Profits and losses are reported on an individual Schedule C as if the company was a sole proprietorship. Therefore, the LLC does not have to file a separate return like a corporation. It essentially avoids double taxation.

Lastly, single member LLCs are not required to file annual reports or minutes like partnerships and corporations do.

Disadvantages of Single Member LLCs

A common filing error of single member LLCs is when founders falsely believe they have a complete shield of legal protection.

For example, neglecting to keep good records can get you in a lot of trouble. You still need to keep records of all profits and losses, including receipts for business expenses you plan to claim as tax deductions.

You need basic things like an operating agreement to prevent someone else from suing you (and ultimately holding you financially liable). The same is true of getting protection from the IRS in the event of an audit.

Furthermore, despite the general belief limited liability companies are not completely shielded from financial responsibility, there are cases in the United States where the courts determined LLCs were liable since single member LLCs are sometimes considered disregarded entities.

To prevent being held liable for entity taxes as a sole proprietor, it is important that you speak to a tax professional and have a clear plan moving forward. Some simple, yet often overlooked tips like filling out a Form 2553 and checking the box to have the LLC treated like an S-Corp can prevent the chance of becoming liable for entity taxes or debt.

Common Tax Filing Errors of Single Member LLCs

Most of the common tax filing errors of single member LLCs come down to a lack of knowledge and understanding of how different entities are taxed in the United States.

Though limited liability companies are intended to reduce or eliminate liability of business debt or protection from lawsuits, it is not always that simple. Every new entity should speak with a licensed tax professional for advice.

Creating an operating agreement, employing thorough recordkeeping, keeping receipts of business expenses, and making the right claims on tax returns goes a long way. The ultimate goal is to establish a paper trail that indicates you have a legitimate separate entity that needs to get treated as such to avoid getting treated as a disregarded entity.

Tax Help from Levy & Associates

Levy & Associates offers practical, helpful advice to our clients. If you are considering creating a single member limited liability company (LLC) to get more legal protection, speak with a qualified tax professional at Levy & Associates.

The initial consultation is free with absolutely no commitment. Contact us at 800-TAX-LEVY, or visit www.levytaxhelp.com.

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