⚡ Get All Content for 20% Off ⚡

LLC 101 Everything you ever wanted to know about forming your company as an LLC--and then some

By Cliff Ennico

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

My recent column on the proper way of compensating the members (owners) of a limited liability company (LLC) generated a ton of e-mail from accountants, lawyers and other tax professionals throughout the country. While most supported this column's handling of the problem, everyone agreed that "the Devil is in the details," and that this has to be one of the murkiest areas in the entire federal Tax Code.

One of my respondents was Alan E. Weiner, a CPA with Long Island, New York-based accounting firm Holtz Rubenstein & Co. Weiner served on a committee of New York CPAs that helped shape that state's LLC law. According to Weiner, all members of an LLC (not just those owning more than 5 percent) are treated as "partners" for tax purposes and cannot receive deductible wages. "Any LLC member owning any percentage, no matter how small, should receive a Form K-1, not the Form W-2 you would use for employees," says Weiner.

If a member will receive a fixed amount of compensation (for example, $50,000 a year) irrespective of the income or loss of the LLC for the year, that is called a "guaranteed payment," which Weiner says is "similar to a salary which an employee receives" and is deductible by the LLC. However, if a working member receives 100 percent of the profits of the LLC business, not a fixed amount, that would not be a "guaranteed payment," since the compensated member receives nothing if there are no profits.

Weiner also points out that LLC members are not required to settle their distributive shares by year-end. "LLCs have up until the time for filing their tax returns--April 15 for a calendar-year LLC--to determine how the LLC's income should be allocated and reported," says Weiner. "That gives the members time to review the financial statements and determine how to allocate the income for tax purposes."

The self-employment tax area for LLCs is a difficult one, according to Weiner, because it is not clear exactly how LLC owners determine their self-employment income. In 1997 the IRS proposed regulations (never formally adopted and therefore not binding) saying that if an LLC member does not work for the LLC in excess of 500 hours during the LLC's taxable year, does not have authority to contract on behalf of the LLC, and does not have personal liability for the debts or claims against the LLC by reason of being a member, he or she is not subject to the self-employment tax on income allocated to the member. "But mathematically," says Weiner, "if the working members are allocated all of the income, there is nothing left for the passive investor and, therefore, with zero self-employment income, there is nothing for passive investors on which to be self-employment taxed."

Finally, Weiner says that an LLC cannot voluntarily withhold income taxes on amounts paid to a member. "What some LLCs do," says Weiner, "is set up a special internal account which is distributed to each member, based on what each member agreed to put into the special account, when quarterly estimated taxes are due, but this is not a voluntary 'withholding tax.' "

IRS Publication 3402, "Tax Issues for Limited Liability Companies," available from the IRS' Web site, goes into these issues in more detail, but Weiner points out that neither this nor any other IRS publication should be used as a substitute for professional advice in this fast-changing and difficult area of tax law.


Cliff Ennico is host of the PBS television series MoneyHunt and a leading expert on managing growing companies. His advice for small businesses regularly appears on the "Protecting Your Business" channel on the Small Business Television Network at www.sbtv.com. E-mail him at cennico@legalcareer.com.

Cliff Ennico is a syndicated columnist and author of several books on small business, including Small Business Survival Guide and The eBay Business Answer Book. This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state.

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Side Hustle

The Remote Side Hustle a 43-Year-Old Musician Works on for 1 Hour a Day Earns Nearly $3,000 a Month: 'All From the Comfort of Home'

Sam Ziegler wanted to supplement his income as a professional drummer — then his tech skills and desire to help people came together.

Business News

Costco CFO Reveals Uncertain Fate of $1.50 Hot Dog and Soda Combo

CFO Richard Galanti reveals that the price will stay the same — but only "for a while."

Business News

The Most Unexpectedly Popular Side Hustle of the Decade Has Low Startup Costs and High Markups

A new report shows that vending machines are a popular investment — and the industry is set to grow up to $3 billion by 2031.

Marketing

Ever Wonder Why Certain Websites Rank Higher Than Yours? This SEO Expert Reveals The Secret to Dominating Search Results

It's often the smart use of SEO, now supercharged with AI, particularly in keyword optimization.

Business News

AI Is Impacting Jobs. Here Are the Gigs Affected the Most, According to an Analysis of 5 Million Upwork Postings

The researcher said in the report that freelance jobs were analyzed first because that market will likely see AI's immediate impact.

Leadership

Former Interrogator Shares 5 Behaviors Liars Exhibit and How to Handle Them

Five deceptive behaviors to look for and how to respond to those behaviors when you encounter them.