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A business as a sole proprietor thinking of changing to LLC.

A business as a...

A business as a sole proprietor thinking of changing to LLC. What would be the tax difference? Does the LLC pay corporate taxes?

Accountant's Assistant: Can you tell me what state the LLC is registered in?

Texas

Accountant's Assistant: Has anything been filed or reported?

Filed 2016 as sole proprietor

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Answered in 5 minutes by:
5/11/2017
Richard
Richard, Tax Attorney
Category: Tax
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Experience: 29 years of experience as a tax, real estate, and business attorney.
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Hi! My name is Richard & I will be helping you today! It will take me a few minutes to type a response to your question. Thanks for your patience!

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There would be no difference tax-wise if you form an LLC as the LLC tax attributes simply flow through to you. The issue is self-employment taxes and whether or not to form an LLC or S Corp. Both the LLC and the S Corp are limited liability entities meaning your personal assets would not be at risk for the debts and liabilities of your entity. And, both are "flow-through" entities for tax purposes...meaning that the entity does not pay taxes; rather the operations of the entities flow through to your own personal tax return. The LLC is more flexible as it allows for preferential allocations of profits and losses, but if you are a single owner, that probably doesn't make much difference. The LLC also is a bit less cumbersome administratively as your filing requirements. And, unlike an S Corp, the LLC is not required to have formal meetings and keep minutes of those meetings. The biggest issue with the LLC is that as the owner of an LLC, you are considered to be self-employed and must pay the 15.3% self-employment tax contributions towards Medicare and social security. As such, the entire net income of the LLC is subject to this tax. With an S Corp, if you work for the entity, you must pay yourself 'reasonable compensation.' Basically, the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as 'wages.' Unlike an LLC, where you are subject to employment tax on the entire net income of the business, only the wages of the S-Corp shareholder who is an employee are subject to employment tax. The remaining income is paid to the owner as a 'distribution' which is either taxed at a lower rate or or not at all depending upon the particular facts. BUT, as shareholder, you must receive reasonable compensation. If you get greedy by paying yourself a lower salary with the resulting higher distributions, you risk the reclassifying your distributions as wages. Typically, the best solution is to form an LLC and then elect for it to be treated as an S Corp for tax purposes; this results in the best of both worlds...the flexibility of an LLC and the advantageous self-employment tax treatment of an S Corp. :)

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I just wanted to let you know that I will be away at a meeting for the next hour or so. Should you have a follow up while I’m away, I will address it immediately upon my return. Thank you in advance for your patience. I apologize for any inconvenience.

Richard
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Thank you so much for the 5-star rating! I know rating takes an additional step and I truly appreciate you taking the extra time! It's been my honor and privilege to help you with this. If I can help you in any way in the future, I'll be happy to help. For easy access, my bookmark is: www.justanswer.com/law/expert-legalbeacon/ . Or, simply request “Richard only” in the first line of your question.

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