A limited liability company (LLC) in Michigan should be viewed as a hybrid for tax purposes. It offers greater protection against personal liability than a sole proprietorship in Michigan since members of an LLC are not personally responsible for the debts of the company. But, in most cases, net income is distributed among members and must be reported as self-employment earnings on individual returns.
Figuring out who must pay what in taxes for LLC earnings is quite complicated and can be altered by the LLC's tax treatment choices. A business person should obtain an overview of the LLC laws in Michigan before deciding these issues.
What Is a Michigan LLC?
An LLC in Michigan is a type of business entity created by the Michigan Limited Liability Company Act of 1993. As a business structure, it is quick and easy to form and can be set up in a few hours. It also offers a lot of flexibility; it can have just one owner or it can be owned by several people.
All owners are called "members," and they usually have equal decision-making authority for the business. In some cases, however, some LLC members are mere investors and do not participate in management. In others, the LLC members prefer to pay a manager to run the company.
Pass-Through Business Tax Structure
Taxing authorities treat an LLC as an entity separate from its members for some purposes but as a pass-through business structure for others. Members of the LLC pay taxes on income as if they had earned it themselves in some cases, but not in others.
It is essential for anyone considering forming an LLC to understand the Michigan and federal rules for LLCs so that all laws are followed, and the LLC is kept up to date.
LLCs and Personal Liability
If an individual member must report LLC income for tax purposes as if they had earned it personally in many cases, why would the owner prefer an LLC business structure to a much simpler sole proprietorship? There is one important feature of an LLC that makes it more attractive than a sole proprietorship in Michigan: it limits the personal liability of individual members.
That is, if the limited liability company doesn't pay its bills, the creditors can sue the LLC. But even when there are not sufficient assets for the LLC debts, creditors cannot seek reimbursement from any member personally.
Contrast that with a sole proprietorship, where the business' debts are the individual's debts. The only assets that can be attached for LLC business debts are LLC assets. An LLC member in Michigan risks only the amount of their investment in the LLC.
Type of LLC Taxes in Michigan
A business in Michigan is subject to a variety of taxes. The primary obligation is for income taxes both at the state and federal levels. Often, the business income is passed through to the members who report it on their personal tax returns.
In general, Michigan tax laws follow federal tax laws as to how LLC income is treated. That is, the LLC can be treated like a sole proprietorship for income tax purposes, but, in different circumstances, it may be taxed as a partnership or corporation.
In addition to income taxation, an LLC in Michigan must, in some cases, pay employment-related taxes, like unemployment insurance taxes. The LLC must also pay state fees and issue annual reports.
LLC Income Treatment for Federal Taxes
Michigan bases its LLC income tax rules on federal Internal Revenue Service (IRS) tax rules. That means that understanding the way the IRS treats the company is the place to start. Generally, the LLC does not file a tax form itself, but its earnings are distributed to the LLC members who must list their share as income on their personal returns.
However, it is a little more complicated than that. In fact, the IRS does not recognize "limited liability company" as a separate tax category. It will always treat an LLC either as a corporation, a partnership or a sole proprietorship. Which treatment will be applied depends on the number of members in the LLC and on the LCC's choices.
Single-Member LLC Tax Treatment
An LLC can be formed by one person alone or it can have more than one member. This impacts federal and state tax treatment.
A single-member LLC can elect to be treated as a corporation by filing Form 8832 with the IRS. If it does not do so, the LLC structure is disregarded, and all LLC income and losses are included on the sole member's individual federal return.
Depending on the purpose of the LLC and the income activity, the owner must report it on:
- IRS Form 1040 Schedule C Profit or Loss from Business (Sole Proprietorship).
- Schedule E (Supplemental Income or Loss).
- Schedule F (Profit or Loss from Farming).
Federal and State Income Tax
The individual owner of a single-member LLC must also pay federal self-employment tax on net earnings from the LLC. This is similar to federal sole proprietorship tax treatment. If an LLC does not elect corporate tax treatment, it does not pay federal income taxes and so does not have to file a tax return with the IRS.
The state of Michigan uses the federal tax structure when it comes to taxing single-owner LLC profits. The owner lists income on their individual state tax return. It is not necessary for the LLC itself to file a state tax return in this case.
On the other hand, Michigan requires a single-owner LLC to file an annual report, due February 15 each year. And an LLC with only one member that has employees is treated as a separate entity for employment tax purposes.
Multi-member LLC Tax Treatment
If an LLC has more than one member, it is classified as a partnership for federal income tax purposes. This is the default classification. But like a single-member LLC, the multi-member LLC can file a Form 8832 with the IRS and elect to be treated as a corporation. Tax treatment at the state level mimics that at the federal level.
When the LLC is treated as a partnership, it is the same type of "pass-through" entity for tax purposes as is a single-member LLC or a sole proprietorship. Partnership income is divided among members, who pay taxes at each partner’s ordinary income tax rate. The partners will also owe self-employment taxes on the partnership income they report unless the LLC paid employment taxes on those amounts.
Note that federal taxes, in this case, must be paid on each member's entire distributive share. That means that, regardless of whether the LLC actually distributes any or all income to its members, they must report their entire “distributive share” on their tax returns each year. This comes up when the LLC members do not take profits from the business, but leave them in the LLC for working capital.
Opting for Corporate Status
If the members of an LLC elect to have their business treated like a corporation for tax purposes, the business itself is required to file separate tax returns for both federal and Michigan state taxes. Corporations report income to the IRS on Form 1120, Corporation Income Tax Return. The corporate form also involves limited liability for members.
Michigan's corporation income tax rate is a flat 6 percent of taxable income. An LLC taxed as a corporation will be obligated to file the state's corporate income tax return (Form 4891) and pay any amount due to the Michigan Department of Treasury. On the other hand, members do not have to include undistributed profits as their own income.
Regarding Self-employment Taxes
As mentioned above, self-employment taxes may be due from LLC members. This applies to an LLC that is owned by one individual or an LLC owned by multiple members and treated as a partnership. Each member is considered by the federal and Michigan taxing authorities to be a self-employed business owner.
Generally, they are not considered to be employees of the LLC, so no employment tax withholding is required of the business.
Given that, every member of the LLC has to cover their own Social Security retirement and Social Security Disability taxes. That means they must pay self-employment taxes on the entire amount of their distributive share of the profits. If that share is $20,000, they must report $20,000 as self-employment income and pay self-employment taxes on it.
Quarterly Tax Remittance
Quarterly estimated tax payments are required. Just like other self-employed individuals, LLC members are required to estimate their income and the self-employment and income tax they will owe for the year.
They must make payments quarterly to both the IRS and the Michigan Department of Treasury. Owners who are mere investors may be exempt from paying self-employment taxes on their share of profits.
Michigan LLC Sales Tax
If an LLC sells physical products or offers certain types of services, the business may have an obligation to collect and pay sales tax on the amount of sales. In Michigan, the sales tax is collected by the business at the point of purchase.
In Michigan, an LLC will usually need to collect and pay sales tax on tangible goods and personal property and certain services. Generally, there is no sales tax on food, medications, clothing or gas. The state of Michigan imposes a flat statewide sales rate of 6 percent. There are no county or municipal sales taxes.
Other LLC Tax Filing Requirements
As described above, LLCs that are treated like sole proprietorships or partnerships do not need to pay income taxes. Still, these LLCs must file documents with the federal and state taxing authorities to show income earned by its members every year. This assists the tax authorities to determine whether LLC members reported the income they were obligated to report.
To facilitate the members' tax preparation, an LLC must also prepare Schedule K-1 for each LLC member, reporting the member's share of the company's profits and losses. Then every member fills in their own individual Form 1040 Schedule E using this information.
Employer Tax Withholdings
If an LLC actually has employees other than members who do the business of the company, the business must pay employer-related taxes like unemployment insurance tax. As an employer, the LLC may also be required to withhold taxes from the salaries paid.
In Michigan, the LLC must file Form 165 with the state to report the full amount withheld. Copies of the W-2 forms must be sent to the state, the IRS and to the employee.
Teo Spengler earned a J.D. from U.C. Berkeley's Boalt Hall. As an Assistant Attorney General in Juneau, she practiced before the Alaska Supreme Court and the U.S. Supreme Court before opening a plaintiff's personal injury practice in San Francisco. She holds both an M.A. and an M.F.A in creative writing and enjoys writing legal blogs and articles. Her work has appeared in numerous online publications including USA Today, Legal Zoom, eHow Business, Livestrong, SF Gate, Go Banking Rates, Arizona Central, Houston Chronicle, Navy Federal Credit Union, Pearson, Quicken.com, TurboTax.com, and numerous attorney websites. Spengler splits her time between the French Basque Country and Northern California.