Freelancers and independent contractors are often urged to get an LLC, instead of sticking with a sole proprietorship or opting for a C corporation.
Why? Generally because they come with some pretty great legal protections.
However, getting one isn't likely to change your tax situation from the outset. For starters, you might still get a 1099, just like a sole proprietor. Whether or not you do depends on how your LLC is taxed.
Understanding the basics of LLCs
An LLC, or a limited liability company, is a type of business structure. It's a way to shield yourself from liability in the course of your trade or business. A corporation does the same thing.
LLCs are formed at the state level. They LLC offer different legal protections, and the extent of your legal protections depends on which state you register in
How LLCs are taxed
Business taxes are complicated, and having an LLC doesn't change that in the slightest.
There are several different types of LLCs, and each one gets a different tax treatment.
This one's simple enough — if you're the only person who owns your LLC, it's a single-person LLC.
A single-member LLC is a "disregarded entity." That means that, when it comes to taxes, a single-member LLC isn't recognized as separate from its owner. The company itself is disregarded, while all its income and losses pass onto its owner.
Owners of single-member LLCs are required to report their business activities on Schedule C of their own personal tax return. That means their income is subject to self-employment tax.
You might want to ask, "How is this any different than being a sole proprietor?". When it comes to taxes, there's essentially no difference — they're both taxed in the same way, and sole proprietors can still get write-offs.
But, of course, the LLC is widely regarded as a business entity for legal purposes. So operating a single-person LLC will bring you less legal risk than running a sole proprietorship.
If you co-own your LLC with someone else, you have a partnership.
Come tax season, partnerships are required to file another IRS form: Form 1065, also known as a partnership tax return. However, owners will still have to deal with the income on their personal tax returns.
Here's how that works. On Form 1065, you'll enter your gross proceeds and gross expenses. Any net income will pass through to you and your partners. That income will be linked to your Social Security number, and the IRS will expect to see it on your income tax return.
Partnership income is usually treated no differently than the business activities of single-member LLCs or sole proprietors as reported on Schedule C. That means it's usually also subject to self-employment tax.
Single-member LLCs and partnerships don't really carry any tax benefits. But this next type of LLC can potentially come with some tax savings.
LLCs taxed as S corps are widely regarded as one of the best business structures for income tax purposes. Essentially, if you set it up properly and study up on IRS rules and regulations, you can shave off some of the self-employment tax liability you'd have with a partnership, single-member LLC, or sole proprietorship.
This strategy involves filing an extra tax form with the IRS, and then paying yourself a salary, almost as if you were a W-2 employee.
This strategy isn't for everyone — it only makes sense if you earn quite a bit through your business. Still, it gives you an idea of how flexible the LLC taxed as an S corp can be. If you'd like to learn more about whether it's right for you, check on our article on the benefits of S corps versus LLCs for independent contractors.
LLCs and Form 1099-NEC
As you know by now, the tax status of your LLC can vary a lot depending on how you set it up. Accordingly, an LLC will only get Form 1099-NEC if it's taxed as either a single-member LLC or a partnership. If it's taxed as an S corporation, it won't receive a 1099.
Issuing Form 1099-NEC as a business owner
If you're a business owner, you might have to deal with both sides of the 1099: receiving and issuing them.
If you buy or rent at least $600's worth of goods or services from a vendor for your business, you might have to file one. When? If they're a sole proprietorship, single-membership, or partnership.
Interestingly, if you want to issue a 1099-NEC for a vendor, it can be hard to figure out whether or not they're taxed as an S corporation. All you'll see in their business name is "LLC".
If you find yourself in this situation, you'll have to ask if they're taxed as an S corp when you request a Form W-9, also known as the Request for Taxpayer Identification Number and Certification. If they are, IRS instructions indicate you're off the hook — don't have to file anything for them!
What an LLC means for self-employment taxes
Here's the final takeaway: LLCs will get 1099-MISC forms as long as they're not taxed as an S corps. And LLC earnings will be subject to self-employment tax.
At the end of the day, filing for an LLC solely for tax reasons may not make sense for you — the key benefit is on the legal liability front.
In any case, whether you're pursuing the legal shield of an LLC, or sticking with a sole proprietorship, it's crucial to find all the write-offs you can. It's the best way to deal with self-employment tax with your budget intact.
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