Most businesses start as a Sole Proprietor and their main focus is to generate sales and your business is going to get exposed to liability
A Limited Liability Company (LLC) is a legal structure for operations and for asset protection.
An LLC is a business created by a statute and governed by the laws of its operating state. The business structure uses pass-through taxation of a sole proprietorship or a partnership combined with the limited liability of a corporation. This is an ideal situation for most business owners.
Each state has its own rules regarding LLCs, but the legal structure is similar. The owner of an LLC is a member, and LLCs can have one member or multiple members.
Forming an LLC provides the ability to keep your personal and business assets separate, results in a much lower amount of paperwork than a traditional corporation, and has the additional flexibility in tailoring your company to your situation.
Some LLCs are designed for professional services (PLLC), such as doctors or lawyers, while others are used to take advantage of interstate commerce laws. Smart business owners often use LLCs over corporations to benefit from the personal liability protection without dealing with red tape, paperwork, or formalities that can be difficult for a small business, young business, or sole entrepreneur.
If you are the only person listed in the LLC, you are considered a single-member LLC and will file Schedule C
If there are two people listed as members or managers in the LLC, that is considered a partnership
The LLC is formed with the State of your residency. An LLC can be taxed as a Sole Proprietor, a Partnership or an S-Corporation
Your business cannot be taxed as an LLC, it can only be taxed as a Sole Proprietor, Partnership or S-Corporation by the IRS
Benefits of moving your LLC to an S-Corp: When the profits of your business (income less expenses) reach around $50K in a year, it is advisable to elect to be treated as an S-Corporation because the S-Corporation can save you thousands of dollars in self-employment tax. This means that you business can start processing payroll for 2 or 3 employees, and the owner can also get a W-2 with a reasonable salary and also pay yourself distributions
When not to switch to an S-Corp: a) when you are starting your business, your focus is to produce income and generate sales; b) when you are participating with passive income activities such as rental income, since you do not pay self-employment taxes when you have passive income.
When you form a business, you are making two decisions: a) you are making a legal decision, and b) you are making a tax decision.
Legal Entity Tax type
Sole Proprietor is taxed by default as Schedule C attached to Form 1040
Single Member LLC is taxed by default as Schedule C attached to Form 1040
Multi Member LLC is taxed by default as Schedule K-1 (Form 1065) attached to Form 1040
C-Corporation is taxed by default as C Corporation Form 1120
Single Member LLC, Multi Member LLC and C Corporations can elect tax treatment as an S Corp by filing form 2553 and at the end of the year will file the 1120-S
C Corporations are subject to double taxation: which means that the profits from the corporation are going to pay tax when they file form 1120 and then the shareholders, the owners of a C Corporation, will pay taxes when they receive distributions from the C Corporation or the Professional Association