Every dollar earned in this country, the IRS wants a piece. It doesn’t care who pays it, as long as it gets paid. Problems only arise when the
Double taxation is basically where a corporation is considered a taxable entity and thus has to file and pay a separate tax return from the owners, or shareholders. First, the corporation does all its accounting and gets its final operating profit before taxes. This is its taxable income and the number which the corporation has to pay taxes on. After calculating its net profits, the corporation can then pay the owners/shareholders a dividend, their percentage of the corporate profits, based on their respective shares of the corporation’s stock. If the corporation chooses not to pay a dividend, then the owners only pay taxes on their individually earned incomes, including any salary paid by the corporation. Thankfully, the owners’ salaries are subtracted before profits are calculated but this doesn’t save them from single taxation just double. However, if a dividend is paid it is added to the owner’s income for the year. In this manner, the owners pay taxes on that dividend, even though money comprising the dividend has already been included, and had paid taxes on it, in the corporation’s tax filings. An LLC does not have this problem.
An LLC does not pay taxes on its income. This is because an LLC is not considered a taxable entity by the IRS, rather, it is a “disregarded entity” and subject to pass-through taxation. Pass-through taxation means that any income generated by the LLC passes through the entity directly to the owner(s). The LLC serves solely as a conduit for the income generated by the owners while protecting them from liability. An important distinction to remember is that while an LLC is a form or conducting business, the
An example of this difference: John and Lucy form Tables LLC to sell tables. They own $10,000 worth of tables. If they are sued, the suit can only affect the holdings of the Tables LLC, the $10,000 worth of tables. Now, assume Tables LLC sells the tables for $25,000 – a tidy $15,000 profit. The
Is your company in a similar situation? Someone has to pay taxes on the income, whether it’s you or your company. If you’re able to choose to have your company treated as a corporation, then your company has to pay taxes on the revenue, even if it doesn’t distribute it. If you’re taxed as an LLC, then your company doesn’t pay anything but you have all of the tax burden, regardless of if you pay yourself a salary or not. In fact, paying yourself a salary doesn’t do you any favors. You’re still exposed to the same tax consequences. This is why you need to start thinking of ways to reduce your tax exposure.
Here are a list of questions you need to think about. Some of them you probably already have answered but they just set the framework:
1) Is your company a LLC?
2) Am I the sole owner of this company?
3) What is the company filing as its income for this tax period?
4) What is a “disregarded entity” for tax purposes?
5) What is pass-through taxation?
6) Is your company subject to pass-through taxation?
7) Is there some legal reason that I am not subject to pass-through taxation for my company’s revenue?
8) How does pass-through taxation affect me and my company?
9) How does your state tax law differ from Federal tax law with regards to LLC’s and pass-through taxation?
10) What deductions and exceptions am I qualified for?
11) Does paying myself a salary expose me to double taxation?
12) Do I use a Schedule C, Form 1120 or a 1092 to file my taxes?
13) For Federal Purposes am I classified as a corporation?
14) Do I have to, or have I, file/d a File Form 8832
For more information please read these articles, particularly the sections regarding taxes:
For more on this please check out my book Millionaire in the Basement due out in 2007.