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Do LLCs Pay More Taxes Than a Sole Proprietorship?

A limited liability company (LLC) is a business structure in the U.S. that protects its owners from personal responsibility for its debts or liabilities. Limited liability companies are hybrid entities that combine the characteristics of a corporation with those of a partnership or sole proprietorship.

On the other hand, a sole proprietorship is a type of enterprise owned and run by one person and in which there is no legal distinction between the owner and the business entity.

In this video, Attorney Burton discusses the tax similarities and differences between and LLC and a sole proprietorship.

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Welcome back!

I'm Attorney Thomas Burton. I'm an estate planning and business law attorney here in Wisconsin and today's question has to do with LLCs and is the following -

"Do LLCs pay more taxes than a sole proprietorship?"

If you watch my channel, you may know that LLCs at least in Wisconsin but also throughout the US, are one of the most popular forms of business entities for a small business and there can be some confusion over the difference between the sole proprietorship and an LLC, but if we have an LLC that's owned entirely by one individual what is called in the parlance a single member LLC, the taxation for a single member's LLC is exactly the same as a sole proprietorship. The reason for this is It's called flow-through taxation, the default status for a single-member LLC meaning the status you will have with the IRS if you do not opt out of it, is flow-through taxation as what they call a disregarded entity.

Let's use an example, let's say you were operating a sole proprietorship, a lawn mowing company and in Wisconsin, you can operate a sole proprietorship by just beginning to do business in your name. Now if you're in a locality that requires a business license, that may be required but generally, to start a sole proprietorship in Wisconsin, it's quite limited paperwork.

If you have a sole proprietorship lawn mowing business, Sam's lawn mowing, you would file the taxes on Schedule C to your individual tax return. You would report the income and expenses.

Now let's say, in January of the following year, you start an LLC called Sam's lawn mowing LLC, because you decided it was a smart idea to limit your liability and separate your business assets from your personal assets by forming this LLC, limited liability company to limit the liability of the business to the business because your lawn mowing business has been going well, maybe you bought a house, you got married, you started to acquire some personal assets over here and now the lawn mowing business is expanding, you're buying more mowers, you're hiring employees, maybe you bought a building things like that. Well the single member LLC, as long as you are the only member, 100% owner, the taxes will be exactly the same as your sole proprietorship meaning all the income and expenses will flow through to you and you'll report them on your individual tax return, on Schedule C.

If you want to opt out of that status, you could, in theory, opt out and be formed, has to be taxed as a C corporation but generally, most small businesses don't want to do this because you pay tax at the entity level and then you would take a dividend and you get taxed on that dividend again.

For a single member LLC, going back to the original question, do they pay more taxes than the sole proprietorship, no, they should pay the exact same amount of taxes meaning tax would be owed on the net business income. You have gross income, total income, less business expenses, is the net business income to the owner, and that's what you would get taxed on and whether you're a sole proprietor or an LLC. you would owe self-employment taxes on that income meaning Social Security, Medicare tax, unemployment tax and income tax, personal income tax rates and then Wisconsin Income Tax on that income.

The taxes add up but from a tax filing status, whether you're a single-member LLC or a sole proprietorship, you won't experience an increase or decrease in your overall tax burden. It's simply what we call flow-through taxation, flows through to you on your individual tax return.

Now, if you're considering being a multi-member LLC, you can also have flow-through taxation, but it works slightly differently. It would come through to the members on a K1 and you would need to file a partnership retaining. If you want to know more about that, watch my video on the difference between a single-member and a multi-member LLC taxation but for today's video, the question of whether a sole proprietorship or an LLC would pay more taxes, the tax should be exactly the same for a single-member LLC versus the sole proprietorship and the reason I'm using single-member LLC is sole proprietorship is by definition owned by one person and the same would be with the single-member LLC owned entirely by one individual.

So great question, thank you for asking, thank you for tuning in. If this video was helpful to you, please consider giving it a LIKE, so that others can see and benefit from the information as well.

Thanks for watching and we'll see you next time.

© 2023 Burton Law LLC. All Rights Reserved. Transcript and captions provided for ease of access for the hearing impaired. For questions about this topic, or to suggest a topic for a future blog post, please contact the office.


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