You’ve just decided to start your own business, and the company you’re working with tells you they will give you a 1099. But you also heard that it might make sense for you to set up an LLC. In this post, we’ll take a look at the 1099 vs LLC.
There are certainly pros and cons to each structure. They start off being taxed the same, but the LLC gives you some added legal protection and the ability to be taxed differently if desired.
You must ask yourself key questions like how many years you plan to be in business and how much money you intend to make. Small business owners commonly use both structures. So, let’s get started.
How is money received from a 1099 taxed?
Money received from a 1099 is considered self-employment income and is subject to self-employment tax and income tax.
Self-employment tax is a tax that self-employed individuals pay to cover their Social Security and Medicare contributions. For the tax year 2021, the self-employment tax rate is 15.3%, comprising a 12.4% Social Security tax and a 2.9% Medicare tax. The Social Security tax fortunately only applies to income up to a specific limit of $142,800 for the tax year 2021. However, the Medicare tax applies to all self-employment income, with no income limit.
In addition to self-employment tax, income received from a 1099 is also subject to federal income tax and any applicable state and local taxes. The amount of federal and state tax owed will depend on the taxpayer’s total income and deductions and their tax bracket.
Self-employed individuals who receive income from a 1099 are responsible for paying both the self-employment tax and the income tax on their own, as the employer does not withhold these taxes. This means it’s important for self-employed individuals to keep accurate records of their income and expenses throughout the year to calculate their tax liability and avoid underpayment penalties accurately. You can also set up retirement plans, including cash balance plans.
How is a single member LLC taxed?
A single-member LLC is classified as a “disregarded entity” by default, meaning that it is not taxed as a separate entity from its owner for federal income tax purposes. Instead, the LLC’s income and expenses are reported on the owner’s personal tax return (Form 1040) using Schedule C.
In addition to self-employment tax, the owner of a single-member LLC is also responsible for paying federal income tax on the LLC’s net income. The owner’s tax liability will depend on their total income and deductions, as well as their tax bracket. The net income of the LLC is calculated by subtracting the LLC’s business expenses from its gross income.
It’s important to note that while a single-member LLC is taxed as a disregarded entity, it still provides liability protection for its owner. This means that the owner’s individual assets are typically protected in the event that the LLC is sued or incurs debts or liabilities.
Are a 1099 and LLC both subject to self-employment tax?
Yes. The IRS considers a single-member LLC as self-employed and is responsible for paying self-employment tax, which includes both Social Security and Medicare taxes that would normally be paid by an employer on behalf of an employee.
| 1099 | LLC |
|---|---|
| Taxed as Sole Proprietorship | Flexible Check the Box Rules |
| No Asset Protection | Limited Liability |
| No Formal Entity Required | Entity Established at State Level |
| Schedule C to Form 1040 | Schedule C, S-Corp or C-Corp, 1099 vs LLC |
The self-employment tax rate is 15.3%, which is comprised of a 12.4% Social Security tax and a 2.9% Medicare tax. However, the Social Security tax only applies to income up to a certain threshold, which is $160,100 for tax year 2023.
What are LLC check the box options?
“Check-the-box” is a tax classification system for LLCs, which allows them to choose how they are taxed for federal income tax purposes. The term “check-the-box” refers to checking a box on IRS Form 8832 to indicate the LLC’s chosen tax classification.
There are three check-the-box options available for LLCs:
- Single-member LLC: An LLC with only one owner is automatically taxed as a sole proprietorship by default. The LLC’s income and expenses are simply reported on the owner’s personal tax return (Form 1040) using Schedule C.
- S-Corporation: An LLC can be taxed as an S-Corporation by filing IRS Form 2553. This allows the LLC to avoid paying self-employment tax on the portion of its income distributed as a shareholder draw as long as the owners pay themselves a reasonable salary.
It’s important to note that the check-the-box options only apply for federal income tax purposes. LLCs may have additional state and local tax obligations, which can vary depending on the state and locality in which the LLC is based.
What are the advantages of being taxed as an S-Corporation?
As stated above, you can establish an S corporation by simply filing form 2553 for the LLC. In fact, if you have an LLC, you do not need to elect to be an S corporation immediately. You can wait several years until you’re ready, then elect later when the timing is right for your business.
There are several advantages to operating as an S-corporation (S-corp). One of the biggest advantages is the potential tax savings. The 1099 vs LLC issue must also consider corporate structures.
Unlike a traditional corporation (C-corp), an S-corp is a “pass-through” entity, meaning that the company’s profits and losses are passed through to the shareholders and reported on their personal tax returns. This can result in lower overall taxes, as the company is not subject to corporate income tax. Additionally, S-corp shareholders may be able to save on self-employment taxes, as they can split their income between salary and distributions.
Another advantage of an S-Corp is the liability protection it provides. Like a C-corp, an S-corp is a separate legal entity, which means that the shareholders are not personally liable for the company’s debts and liabilities. This protection can help to safeguard personal assets in the event that the company is sued or experiences financial difficulties. Additionally, operating as an S-corp can help to establish credibility with customers and clients, as it is viewed as a more formal business structure than a sole proprietorship or partnership.
S-corporations can work great for established business owners. In fact, I would call them the “bread and butter” tax structure for most small businesses with consistent income.
Is it better to be a 1099 or LLC?
The choice between being a 1099 contractor or forming an LLC will depend on your individual circumstances and goals. The 1099 vs LLC debate requires careful examination.
As a 1099 contractor, you are considered self-employed and must pay self-employment taxes, which includes both Social Security and Medicare taxes. You may also be responsible for paying estimated taxes throughout the year. However, as a 1099 contractor, you have the flexibility to work for multiple clients and have control over your work schedule and business operations.
On the other hand, forming an LLC can provide liability protection for your personal assets and can offer some tax benefits. An LLC may choose to be taxed as a sole proprietorship, S-corporation, or C-corporation, depending on the needs of the business. This gives the business owner greater flexibility in tax planning and can potentially lower the overall tax liability for the business. Additionally, an LLC may be viewed as more professional and may provide more credibility when working with clients.
Ultimately, the decision between being a 1099 contractor or forming an LLC will depend on your individual circumstances, goals, and risk tolerance.