Dealing with taxes as a single-member LLC is very different than that of a multi-member LLC. Single-member LLC taxes are paid as if the business is a sole proprietorship, and thus, the business is a disregarded entity for tax purposes.
All that really means is that your business return is filed on Schedule C of your personal tax return. Single-member LLCs will still have the liability protection afforded to them by forming an LLC, but their tax filing status will look as if they never formally created the business in their state.
That being said, it is much easier from a tax standpoint since there is only one tax return to file, but there are still some important practices that you should have in place.
1. Separate Bank Accounts
For starters, having a separate bank account is essential for maximizing your potential tax deductions. If the IRS can’t tell the difference between a personal expense and a business expense, then those potential deductions will most likely be disallowed. This is not a situation you want to be in so set your business up right from the start.
Single-member LLC taxes are pretty straightforward to begin with so you don’t want to over-complicate things by having poorly documented transactions.
2. Keep Documentation
If anyone ever tells you that you don’t need your receipts, run!
Documenting your expenses, income, travel, meals, etc. is integral to maximizing your tax deductions. The tax requirements for single-member LLCs (and sole proprietors) are no different than any other business. Documentation equals audit proofing, and that is a good place to be.
3. Taking Cash Out of the Business
Taking money out of the business is about as easy as it sounds, but it’s important to verify that you actually have the cash to take out.
Will you be able to pay your bills? Will employees still be paid? Are you behind on collections or paying vendors? Do you have enough cash to handle your obligations for the next several weeks or months?
After analyzing your cash status, you should definitely take cash out of the business if it makes sense to do so.
If you’re a single member LLC, you will take money out of the business through member distributions. (For sole props, these are called owner draws.) This is just a fancy way on paper of taking money out of the business, but these transactions should be well-documented.
When you take a member distribution (or an owner draw), you should write a check from the business account to yourself, and write ‘Member Distribution (or Owner Draw)’ on the memo line of the check for documentation purposes. This is the most clear cut option; however, you can also transfer money directly from the business account to your personal account. Just be sure to account for it correctly.
4. Estimated Tax Payments
As a member in an LLC (or as a sole proprietorship), you will pay taxes on the profits of the business, not the actual money you withdraw from the company. This is because LLCs (and sole proprietors) are pass-through entities that pay no tax at the business level.
These taxes must be paid to the IRS in the form of estimated tax payments by business owners. This is the equivalent of tax withholding by your employer when you’re an employee. All of your income for the year along with your tax withholding (if any) must be considered when determining your estimated tax payments.
The estimated tax payments are paid in either one lump sum during the first quarter of the year or in four equal, quarterly payments throughout the year. These payments can be made through the EFTPS (Electronic Federal Tax Payment System) website or through various other methods.
If you have a new business with a large amount of income late in the year, you will most likely need to adjust your estimated tax payments to accommodate the increase in your tax liability as the year progresses.
Just be sure to pay at least 90% of this year’s tax liability or 100% of last year’s tax liability (110% for high-income earners) to avoid penalties.
5. Paying Your Taxes
When you take money out of the business, you always need to think about your taxes. Estimated taxes are required to be paid by business owners depending on their unique tax situations.
You will need to consider all of the income you have amassed throughout the year including any business profits to make sure your taxes are covered. Since estimated taxes are a personal expense, they cannot be paid directly from the business account. (The IRS frowns upon it.)
When dealing with member distributions (or owner draws) and estimated taxes, use one of the following methods.
Option 1:
- Deposit the money into your personal bank account.
- Put aside 25-30% of it into your personal savings account.
- When estimated taxes are due, pay them out of your personal savings account.
Option 2:
- Deposit the money into your personal bank account.
- When you need to pay your estimated taxes, take the tax amount due out of the business (this could reside in the business savings account until needed).
- Once the money is deposited into your personal bank account, pay your estimated tax payment from your personal bank account.
Option 1 is the cleanest option from an accounting perspective, but it’s up to you. Whatever you decide to do, make sure there is enough money in the business account to run the business after the money is taken out, and always keep a record of the transactions.
Remember: You will pay taxes on the business’ profits, not on how much money you withdraw so it’s up to you to cover the tax bill if you choose to leave a large sum of money in the business.
Summing it up
Overall, the taxation of single-member LLCs (and sole proprietors) is very simple, but you still have to follow the same rules as anyone who is self-employed. Keeping up with documentation and staying current on your estimated tax payments will help you as you navigate your specific business requirements.
Here is a flowchart that you can use to breakdown the tax treatment for single-member LLCs and sole proprietors.
Download Single-Member LLC Tax Flowchart
For more information on single-member LLC, check out the IRS website here.
Note: This blog post is meant for educational and informational purposes only. Please contact a tax or accounting professional if you have specific questions about what this means for your business before taking any further action.