Doc said:
If anyone on this forum is an accountant, would you please tell me if I have to pay additional tax for creating a Limited Liability Company? The guidelines say that I'd have to pay a "self-employment" tax, but the business is only part-time (seasonal).
I guess what I want to know is the advantages/disadvantages of forming an LLC (not a corporation). If anyone has experience in this area, please share.
Doc, my hubby is a tax accountant...he does this for a living!
Here's Brad-
In most cases it is correct that you'd have to pay self-employment (SE) tax on any earnings from a LLC. SE tax is the equivalent to an employee's social security tax. Unfortunately, with no employer to split the cost of the SE tax, as an LLC member, you get stuck paying the entire tax (15.3%) by yourself. Add that to the income tax (from 10% to 35% depending on the rest of your income), and the total percent you're paying in tax is between 25-50%!
This describes what happens when you register the LLC with the IRS to be taxed as a partnership. You could register the LLC to be taxed as a C corp, but the results wouldn't be much better. (A quick comment about the SE tax-even though it sounds oppressive, it's there to right a potential wrong. If you owned and worked at an LLC all your life and you did not pay any SE tax, then you would not be eligible for social security when you retire. You're paying a tax to make sure your not left out of that system. How long that system will exist, however is completely different, frustrating topic).
The above applies to an LLC taxed as a partnership regardless of how long you conduct business. What will be more important is your personal effort in the activity. For tax purposes the IRS has various tests to determine if the business is a "hobby" to you versus a true business. The simplest test is if you spend 500 hours or more in the LLC. If you do, that would allow you to deduct any LLC loss against your other income (profit of an LLC is taxed regardless of whether it qualifies as a hobby). There are 9-10 other tests that can be used in defining the business as a hobby, and the answer to the tests is determined each year. In most cases, you'd want to avoid the business being a hobby.
Some of the rest of the story on LLC's:
- must be registered with the Secretary of State
- may an unlimited number of members or just one (be aware of legal and tax aspects of "single-member" LLCs)
- some states do not permit some businesses (for example banks) to be an LLC
- liability protection to individual members
- can have a perpetual or limited life (a regular partnership "dissolves" when a partner dies)
- ownership interests in an LLC can be sold
- almost any other kind of entity may be a member of an LLC
There's more, but those are the highlights. The basic benefit of an LLC is the limited liability, and if you're product or service does not put yourself or anyone at a substantial risk, then the exercise of setting up an LLC is not worth it, unless you feel you have substantial assets to protect. If you are still interested, contact your Secretary of State's office and ask about forming an LLC. If you decide then that it is the correct form for your business, I would suggest contacting an attourney to help get it set up to your specifications.
April here...Hoped that helped! I'll be doing the same thing here in a month or so. Boy, am I glad I married an accountant!!
