Why did our family income jump so much after switching from 1099 to LLC? Tax implications confused me

The switch from 1099 to LLC isn't actually causing the income difference you're seeing - it's likely a change in how your parents are reporting their business income and expenses. When your parents were 1099 contractors, they probably filed a Schedule C for self-employment income. As an LLC with a single owner (or married owners), they're still considered a "disregarded entity" for tax purposes, which means they still file Schedule C the same way. The LLC itself doesn't change how taxes are calculated. What's probably happening is a change in how expenses are being categorized or calculated. The $20-30k difference likely comes from expenses that were previously deducted but now aren't being claimed. I'd look closely at the Schedule C from before and after the switch - specifically the "Cost of Goods Sold" section versus the "Expenses" section. Some costs might have shifted between categories or aren't being claimed at all. The COVID year showing higher gross receipts is particularly odd. There might have been PPP loans or other assistance that got reported as income. Or, the company might have changed how they report the total sales before your parents' 60% cut.

I had a similar situation when I switched from independent contractor to LLC for my consulting business. The tax headaches were real! I spent weeks trying to figure out what was happening with my returns until I discovered taxr.ai (https://taxr.ai) - it's this cool AI tool that analyzes your tax documents and explains exactly what's changing between years. I uploaded my returns from before and after the LLC switch, and it highlighted exactly which deductions had changed and why my reported income was so different. The tool explained that my accountant had been categorizing expenses differently after the LLC formation, which made my income appear much higher despite earning roughly the same amount. It saved me from potentially missing out on some tax benefits, and I think it might help your family understand exactly what's happening with those deductions that seem to have disappeared.

Just wanted to follow up about that taxr.ai tool someone mentioned. I was super skeptical but decided to try it with my husband's small business returns since we had a similar situation switching from sole proprietor to LLC. Honestly, it was eye-opening! The tool immediately identified that our accountant had started categorizing vehicle expenses under "Other Expenses" instead of the specific vehicle expense line, plus we were no longer taking home office deductions after the switch even though we still qualified. That alone accounted for about $14K in "phantom income" that made us look like we earned more when we actually didn't. For the original poster - it might really help your family figure out exactly what changed in how expenses are being reported. Worth checking out especially if you're applying for financial aid where income thresholds matter.

If you're having trouble understanding what happened with your taxes and need to speak with the IRS directly, I recommend checking out Claimyr (https://claimyr.com). I was in a similar situation last year where our business structure changed and our reported income suddenly jumped by $25K with no actual increase in earnings. After getting nowhere with the IRS's regular phone line (2+ hour waits only to get disconnected), I used Claimyr's service to get a callback from the IRS within 30 minutes. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c The IRS agent I spoke with was able to explain exactly how the business structure change affected our tax reporting and which deductions we were missing. Turns out we could file an amended return and properly categorize some expenses we had overlooked.

I have to eat my words about that Claimyr service. After weeks of frustration trying to get answers about my LLC tax issues, I decided to try it as a last resort. I was completely shocked when I got a call back from an actual IRS agent in about 45 minutes. The agent walked me through exactly what happens when you transition from 1099 contractor to LLC status. In my case, I discovered my accountant had been unnecessarily conservative with deductions after the switch. The IRS agent confirmed I could still claim home office, vehicle expenses, and certain other deductions that my accountant had stopped taking. For the original poster - have your parents talk directly with an IRS rep about their specific situation. The guidance I received saved me over $15K in taxes through an amended return, and it might help your family's reported income look more accurate for your scholarship applications.

One thing nobody's mentioned is that when your parents formed the LLC, did they elect S-Corporation taxation? Many small business owners switch from Schedule C filing to S-Corp status (which requires forming an entity like an LLC first) to save on self-employment taxes. If they did this, the big difference you're seeing might be because with an S-Corp, your parents should be paying themselves a "reasonable salary" which is subject to payroll taxes, with the remaining profit distributed as "distributions" that aren't subject to self-employment tax. This completely changes how income and expenses flow through to the tax return. Ask your parents if they're filing Form 1120-S rather than Schedule C now. That would explain the major differences you're seeing.

Just to add something nobody mentioned - when your parents switched to an LLC and possibly S-Corp taxation, did they start taking inventory into account differently? This could explain the weird cost of goods sold numbers. With a Schedule C, some small business owners are more casual about inventory tracking. But with an LLC, especially if they've switched to accrual accounting, the timing of when inventory is purchased versus when it's sold can cause huge swings in reported income from year to year.