Updated: April 30, 2024

How to save taxes with a single-member LLC

Published By:

Jon Davis

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If you run a business with no employees other than yourself, then you’re in good company:

 

33.2 million small businesses are individually operated in the United States, according to the US Small Business Administration. As a team of one, a lot of key decisions will fall to you, including selecting the right structure for your business entity.

 

Your options include establishing as a sole proprietorship or single-member limited liability company (LLC). And while making this decision may not be the most exciting part of being your own boss, it is one of the most important decisions you’ll make. The business structure you select influences everything from your tax responsibilities to the paperwork you’re required to file and the risks to your personal assets.

 

While a sole proprietorship is the “simplest and most common structure chosen to start a business,” according to the U.S. Small Business Administration (SBA), you may want to consider becoming a single-member limited liability company (LLC), in part, because of the potential tax advantages.

It’s always wise to turn to a trusted advisor, like your accountant, for guidance on the business structure that’s right for you, but let’s take a closer look at the basics.

 

What is a single-member LLC?

A single-member LLC is just as it sounds a limited liability company with one owner (referred to as a member). It’s an alternative to being a sole proprietor, but with some notable differences.

 

One of the biggest benefits of operating as a single-member LLC is that, in most instances, it protects you from personal liability. This means that when forming an LLC, the company becomes its own legal entity and your personal assets like your house and vehicle won’t be at risk if your company faces lawsuits or bankruptcy.

 

Establishing a single-member LLC does require some legwork. Start-up requirements vary from state to state, but this typically includes filing Articles of Organization (part of a legal document used to establish an LLC at the state level),and paying legal and filing fees, which range from around $50 to $800 depending on the state.

 

And on an ongoing basis, once your business is registered and established, there may also be annual fees (from zero to $800+) as well as reporting requirements in your state, so it pays to do some research.

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What’s the difference between a single-member LLC and a sole proprietorship?

One of the main reasons a sole proprietorship (also sometimes referred to as a sole-tradership) is among the easiest and most common business structures is because you don’t have to take any formal action to become a sole proprietor, such as filing paperwork. For example, if you’re a freelance writer, then presto! you’re already a sole proprietor.

 

However, unlike a single-member LLC, as a sole proprietor, there’s no legal separation between you and your business. That means you can be held personally liable for the debts and obligations of the business. To put it another way, being a sole proprietor does entitle you to all company profits, but you’re also responsible for all the business’s debts, losses, and liabilities. It’s something to keep in mind as you determine the best path for your needs.

 

Here is a breakdown of the primary differences to consider:

 

Differences between single-member LLC & sole proprietorship

 

Sole Proprietorship Single-Member LLC
No action or paperwork needed to establish Requires filing Articles of Organization and may also involve filing ongoing annual reports or other compliance-related paperwork
No legal separation between you and your business—you are liable for debts and losses You are protected from personal liability if the company faces bankruptcy or litigation
No fees involved in set-up Initial set-up fees range from $50 to $800. There may also be annual fees of as much as $800.

 

But these aren’t the only differences between the two structures. There are also tax differences to keep in mind.

Tax advantages of single-member LLC

Beyond limiting personal liability, the flexibility in taxation is likely the second biggest benefit of forming an LLC.

 

Typically, a single-member LLC is taxed the same as a sole proprietorship, meaning that your LLC is considered an “entity disregarded as separate from its owner” in the eyes of the IRS. As a pass-through entity, any business tax obligations are passed on to your personal tax return through a Schedule C.

 

An LLC, however, can elect to be taxed as a corporation either a C Corporation or S Corporation. This option can reduce your self-employment tax burden, because only the salary you pay yourself is subject to self-employment taxes.

 

As a C Corporation, profits are taxed at the corporate income tax rate, which could prove to be advantageous. There is, however, the risk of double taxation when your company is taxed on its profit, and taxed again when dividends are paid to you on your individual tax return.

 

When you choose to be taxed as an S Corporation, however, you can avoid the downside of a double tax hit. Income tax gets reported on your personal income tax return without being subject to corporate tax rates.

 

According to SCORE, a nonprofit organization and resource partner of the SBA, generally, “LLC owners find the S corp option more attractive than the C corp because, with C corp tax treatment, profits are taxed at the corporate level, and then the distributions made to the owner are taxed on the individual level, as well.”

 

Something business owners should also keep in mind is that while they will not be paying self-employment taxes on their entire profit, they’ll need to pay FICA taxes and regular income tax on their salary, if they choose to be taxed as an S corp.

 

In terms of business structures, there can be a lot to keep track of, so we’ve included a quick overview below for reference:

 

Business structure Ownership Liability Taxes
Sole proprietorship One person Unlimited personal liability Personal tax only – Pass-through
Partnerships Two or more people Unlimited personal liability unless structured as a limited partnership Self-employment tax (except for limited partners)

Personal tax

Pass through

Corporation – C corp One or more people Owners are not personally liable Corporate tax

Dividends/etc

Owners file W2

Corporation – S corp One or more people, but no more than 100, and all must be U.S. citizens Owners are not personally liable

Can’t have money in the accounts at the end of the year

Personal tax

Owners draws or W2s

Pass through

Limited liability company (LLC) One or more people Owners are not personally liable Self-employment tax

Personal tax or corporate tax

Pass through

Corporation – Nonprofit One or more people Owners are not personally liable Tax-exempt, but corporate profits can’t be distributed

Benefit from tax deductions

As a single-member LLC filing as an S corp, you may also be able to deduct expenses that are not deductible for those filing as a C corp. While occasionally overlooked, don’t sleep on these potential savings: they can add up!

 

For instance, many single-member LLC owners and sole proprietors work from a home office and might not realize they’re able to deduct personal expenses such as internet, phone, or even their vehicle. Additional deductions could include promotional events held at your home (or elsewhere, such as a trade show), subscription costs for publications related to your business, and licensing fees to conduct your business.

 

Here is a breakdown of key points associated with the different tax structures:

 

S corp tax structure benefits at a glance

Only taxed once. You avoid the downside of a double tax hit.

Income tax gets reported on your personal income tax return without also being subject to corporate tax rates.

 

Risk of double taxation when your company is taxed on its profit, and taxed again when dividends are paid to you on your individual tax return.

 

S Corp C Corp
May be able to deduct losses on personal income taxes if you meet certain criteria Cannot write off losses on personal income tax returns
Organizing as an S Corp may result in lower self-employment tax C Corps subject to lower maximum tax rate than S Corps

 

There are many factors to consider when determining the best tax status for your LLC. If you are trying to figure out the best fit for your needs, it can be a good idea to reach out to your accountant for their thoughts.

How do I pay myself as the owner of a single-member LLC?

As a single-member LLC, you don’t get paid a traditional salary. Instead, you withdraw money from your business account as needed, which is referred to as an “owner’s draw.”

 

Definition: An owner’s draw is money taken from the business equity account or profits for personal use or expenses.

 

As the owner, you can withdraw as much as 100% of the equity, but should keep in mind that doing so will leave your business with little to operate.

 

It’s a good idea to consider various factors when deciding the timing and amount of an owner’s draw including your business’s cash flow, historically busy or slow seasons, and expected operating expenses. Ultimately, the IRS advises paying yourself a “reasonable” salary, but leaves it up to you to determine what that amount is.

 

If your LLC is taxed as a corporation, you’ll be considered an employee and you may have to pay yourself through payroll. This means you must follow the same tax rules as any other employer, including withholding payroll and income taxes from your pay and filing quarterly employer tax returns.

Pro Tip:

While the specific amount and timing of an owner’s draw is up to you, there are some best practice steps to follow so that you have a paper trail.

  • Draft a check on your business account that is made payable to yourself and deposit the check into your personal bank account
  • You can also make a direct deposit from your business account to your personal account
  • Keep a record in your business accounts of this withdrawal. Your paper trail can either be in the form of a check or records of an online transfer.

Paying taxes on an owner’s draw as a single-member LLC

Keep in mind that you’ll need to set aside enough money to pay your tax bill come tax season if you utilize an owner’s draw.

 

This is because when using the owner’s draw form of payment, there is no tax withholding from your pay. But that money is still considered taxable income and as such, you’ll be required to report it to the IRS and pay federal, state, and local taxes on the money just like any other form of earned income.

 

As a single-member LLC, of course, you don’t file separate IRS returns for your business. But rather, report your business profits and losses on a Schedule C that’s submitted as part of your personal income tax filing. This process requires paying taxes on all of your LLC profits—even if you did not draw those profits to pay yourself.

Paying taxes as a corporation

If you decide to have your LLC taxed as a corporation that changes the game a bit.

 

If your LLC is taxed as a corporation, you’ll be considered an employee and you may have to pay yourself through payroll. This means you must follow the same tax rules as any other employer, including withholding payroll and income taxes from your pay and filing quarterly employer tax returns.

 

Partnering with a payroll service provider can help ensure you remain compliant and up to date on any legislative changes when you opt to pay yourself through payroll.

Related reading

After you’ve gained a better understanding of how a single-member LLC operates, read our guide to Form 8832, which explains how to elect a new tax classification.

Advantages and disadvantages of a single-member LLC

For many, structuring a  business as a single-member LLC can make sense given the many potential benefits.  It’s important, however, to weigh all of the pros and cons when determining what’s best for you.

  • Pro: No personal liability. When structured as a single-member LLC, you are protected from personal liability in association with the business. This can be important if you’re operating a high-risk business.
  • Pro: Personal asset protection. In the event of bankruptcy, creditors cannot pursue your home or personal holdings. This can be helpful if you have significant personal assets.
  • Pro: Tax benefits. Because single-member LLCs are considered “disregarded entities” by the IRS, there’s no separation between the business and the owner for income tax purposes. In other words, business profits are passed through and reported on your personal income tax returns. You’ll also be able to write-off expenses associated with your business.
  • Con: Increased set-up cost. Remember, a LLC involves a bit more set-up including paperwork and costs. This typically includes filing Articles of Organization. Your initial filing fees could be as high as $800.
  • Con: Ongoing maintenance and filing requirements. Even after you’ve registered your business, you’ll still have filing requirements to meet and fees to pay. Depending on where your business is located, you may need to file an annual report or pay franchise taxes. The state of California, for instance, charges an $800 annual franchise tax.

Keep learning

Keep investigating whether you want to expand your business in the coming year (and seeking capital to do so), we have a resource on how SBA loans work that can provide further useful guidance.

Parting tips

It’s important to think carefully about the structure that might work best for you and your business, sorting through such questions as your ability to keep up with filing requirements, the tax benefits, and protection from bankruptcy and liability.  While it is possible to convert to a different business structure down the road, this process may not necessarily be easy. There could be restrictions based on your location and it could result in tax consequences, among other complications.

 

According to Section 446(e) of the Internal Revenue Code, taxpayers are required to obtain consent from the IRS before changing a method of accounting for federal income tax purposes. You also may need to re-register with the IRS, and could end up receiving a new EIN, so it’s best to get it right at the start.

 

In the end, turn to a trusted advisor such as an accountant for guidance on the business structure that’s right for you.

 

Please note all material in this article is for educational purposes only and does not constitute tax or legal advice. You should always contact a qualified tax, legal or financial professional, in your area for comprehensive tax or legal advice.

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Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.