There can be benefits to starting an LLC or remaining a sole proprietor for both legal and tax purposes. For the legal benefits, you will want to consult with a business attorney. For tax purposes it breaks down as follows:
1. A Single Member LLC is considered a disregarded entity meaning that all income and expenses are reported on a Schedule C on the individual's personal Form 1040. The resulting net income would be subject to self-employment tax as well as income tax.
2. A Multi Member LLC is considered a partnership entity meaning that all income and expenses are reported on a Form 1065.. All partners will receive a K-1 from the partnership and then report the resulting income or loss on a Schedule E on the individual partner's Form 1040.
3. If the LLC files Form 2553, it can elect to be taxed as an S-corporation. If the IRS approves, the LLC will report all income and expenses on Form 1120S. All shareholders will receive a K-1 from the s-corp and then report the resulting income or loss on a Schedule E on the individual shareholder's Form 1040.
In neither case can you deduct federal income taxes. However, state taxes can be deducted on the federal tax return but not the state tax return. In all cases, the resulting income is subject to income tax. In all cases, the resulting loss may reduce other taxable income depending on the nature of the activity, if the owner materially participates, and if the owner has basis in the entity.
