I keep seeing this phrase 'an LLC is taxed like a sole proprietorship' and it's confusing me. If I form an LLC, am I not a separate entity? Why would it be taxed like a sole prop? What am I missing here?
LLC tax
Why do people say an LLC is taxed like a sole proprietorship?
Default tax classification. Single-member LLC = disregarded entity, so IRS treats it as sole prop. Multi-member = partnership by default. You can elect S-corp or C-corp if you want.
the LLC is a legal entity, not a tax entity. That's the whole thing. It gives you liability protection but doesn't change how you're taxed unless you file an election.
So the 'LLC' part is just state-level legal stuff? The IRS doesn't care?
Correct. IRS doesn't recognize LLC as a tax classification. It's a state law thing. For federal tax, you're eithre a sole prop, partnership, S-corp, or C-corp.
And honestly for a lot of small businesses, that's fine. No double taxation, simpler paperwork. The liability protection is the main reason to form one.
Until you start making enough that self-employment tax stings. Then you look at S-corp election. But that's a whole other can of worms.
Wait, so if I have an LLC and get sued, my personal assets are protected, but for taxes it's like I don't even have an LLC? That seems weirdly convenient.
Yep. Liability shield at state level, pass-through taxation at federal level. It's a feature, not a bug.
Just dont commingle funds. If you treat the LLC like your personal piggy bank, courts can pierce the veil and then you lose both the liability protection and the tax simplicity isn't worth much.
So basically the saying is accurate for default single-member LLCs, but it's oversimplified. Got it.
Oversimplified is the internet's favorite flavor.
I still don't get why anyone would elect S-corp then. Sounds like more paperwork for maybe saving on self-employment tax.