Question 1

How are LLCs taxed by default?

Accepted Answer

A single-member LLC is a "disregarded entity" for tax purposes, meaning it is taxed like a sole proprietorship. All net business income flows through to your personal tax return (Schedule C) and is subject to both income tax and self-employment tax (15.3% for Social Security and Medicare). Multi-member LLCs are taxed as partnerships by default, with similar pass-through treatment.

Question 2

What is the S-Corp election and how does it save taxes?

Accepted Answer

An S-Corp election (Form 2553) allows your LLC to be taxed as an S Corporation. Instead of paying self-employment tax on all profits, you pay yourself a "reasonable salary" and only pay payroll taxes on that salary. Remaining profits are distributed as dividends, which are not subject to self-employment or payroll tax. This can save thousands in SE tax, especially for higher-income LLCs.

Question 3

What is a "reasonable salary" for an S-Corp?

Accepted Answer

The IRS requires S-Corp owner-employees to pay themselves a salary that is reasonable for the work they perform. There is no exact formula, but the IRS considers factors like the type of services performed, comparable salaries in the industry, your experience and training, and the time devoted to the business. Setting your salary too low risks IRS reclassification of distributions as wages, plus penalties.

Question 4

When does an S-Corp election make sense for an LLC?

Accepted Answer

An S-Corp election typically becomes beneficial when your LLC net income exceeds $40,000 to $60,000 per year. Below that threshold, the additional costs of payroll processing, a separate corporate tax return (Form 1120-S), and state fees may outweigh the SE tax savings. The higher your net income, the greater the potential savings, as long as you maintain a defensible reasonable salary.

Question 5

Do LLCs pay state taxes?

Accepted Answer

LLC income passes through to your personal return, so it is subject to your state income tax (if applicable). Some states also charge an annual LLC fee or franchise tax regardless of income. For example, California charges an $800 minimum franchise tax plus an additional fee on gross receipts over $250,000. Check your state for specific LLC filing requirements and fees.

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