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Chapter Four

Entity Taxation

All right, I told you it was coming. I know just the thought of taxes gets the blood boiling for some of you. And for the rest of you, the time and trouble it takes just to compile the darn paperwork constitutes one of life’s major annoyances.

But we’ll get through it quickly and efficiently. You’ll receive enough information to understand the landscape and, hopefully, be able to sit down with your accountant and map out your strategy. We’ll briefly review certain LP and LLC, as well as Corporation, Sole Proprietorship and General Partnership, tax information to help you make informed decisions as to which entity is right for you.

Sole Proprietors and Single-Member LLCs

For Sole Proprietorships and single-member (one person) LLCs the tax reporting requirements are very basic. You do not have to prepare or file any additional tax returns. You simply attach a Schedule C, Profit or Loss from a Business (or other schedule, if applicable), to your Form 1040 individual return. On the Schedule C you will detail your profits or losses from your Sole Proprietorship or single-member LLC.

In addition, Sole Proprietor and single-members of an LLC will file a Schedule SE, Self-Employment Tax with their Form 1040. On this schedule you will calculate the amount of self-employment tax (Social Security and Medicare) owed. Currently, the self-employment tax is 12.4 percent for Social Security on earnings up to a statutory maximum of $127,200 as of this writing, and 2.9 percent for Medicare. You may deduct half of the self-employment tax from your income before you pay your personal income tax. All monies flowing through your Sole Proprietorship or single-member LLC will be subject to self-employment tax. There is a difference, however, in how the two entities file their Self Employment Tax Schedule. With the Sole Proprietorship you will use your Social Security Number to file. With a Single Member LLC you will obtain a separate tax identification number and use it for all filings.

Although more fully discussed below, it should be noted here that limited partners, S corporation shareholders and members without active participation in an LLC do not have to pay self-employment taxes on allocated profits. This can be a useful planning strategy.

General Partnerships, Limited Partnerships and Multi-Member LLCs