Understanding LLC taxation is an important component of launching and operating an LLC, so keep reading to learn more.
Whether you’ve just formed or are looking to form an LLC, you’re probably wondering how taxes on an LLC work. By default, an LLC isn’t treated as a separate tax entity like a corporation and is instead treated as a pass-through entity like a sole proprietorship or partnership. However, an LLC also has the option to be taxed as a corporation.
Being taxed as a pass-through entity means that the LLC’s profits and losses pass through to the LLC owners, also called “members,” who will report them on their personal tax returns. Generally, the LLC itself won’t need to pay federal income taxes. However, some states do have an annual tax or other taxes for LLCs. Keep reading to learn more about LLC taxation and all that it entails.
Usually, the IRS will treat your LLC as a sole proprietorship if it has only one member or a partnership if it has multiple members. You can also elect to be taxed as an S corporation or a C corporation.
Single-member LLCs don’t have to file a separate federal return for their LLC. The owner reports the LLC income on their personal income tax return (Form 1040). But LLCs with multiple members must file a separate informational federal return for the LLC, Form 1065. Then each LLC member reports their share of the profits on Schedule K-1 and attaches it to their own personal federal tax return.
Although LLCs are taxed as sole proprietorships or general partnerships by default, LLCs also have the option to be taxed as corporations. Some LLC members choose to classify their businesses as an S corporation or a C corporation, which can be advantageous in some cases. In particular, many LLCs elect to be taxed as S corporations because it can save the members money on self-employment taxes. You can learn more on our “What Is an S Corp?” page.
Filing as an S or C corporation requires an LLC to file a separate federal tax return for the business and follow the appropriate corporate filing requirements.
Filing state taxes as an LLC will vary from state to state. Consult a qualified tax professional to make sure you’re following your state’s guidelines.
Single-member LLCs are treated like sole proprietorships for tax purposes, meaning the LLC itself doesn’t pay taxes and doesn’t have to file a return with the IRS. Instead, the sole owner of the LLC must report all profits and losses for the LLC on their 1040 tax return.
Multi-member LLCs are treated like partnerships for tax purposes. Like a single-member LLC, a multi-member LLC would not pay federal income taxes on business income. Instead, the LLC members each pay federal income taxes on their respective share of the profits on their personal income tax returns.
Typically, LLC profits are “passed through” to members’ personal tax returns at the federal level. However, if an LLC is structured as a C corp, it can be taxed like a corporation at the federal and state corporate tax rate. This setup creates double taxation, where profits are taxed at a corporate level and again at the individual shareholder level.
At the time of this writing, the federal corporate income tax rate is 21%, and individual federal income tax will depend on an individual’s income. In addition to this, most states have an additional corporate tax rate and individual tax rate.
If you’re operating your LLC as a pass-through entity, you’ll need to look up the personal tax rate in your state for your tax bracket. Also, research any local taxes you would need to pay at the personal level. If you’re having your LLC taxed as a C corporation, you’ll need to look up your state and local corporate tax rate as well as the personal tax rates to see what you’ll owe.
Here are some other things to consider about LLCs and taxes.
If the LLC isn’t structured as a C corporation, it’s treated as a “pass-through” entity by the IRS. This prevents double taxation because the business itself isn’t taxed on its profits before being distributed to the members. Profits or losses are reported only on members’ personal income taxes.
You have greater control over how you’re taxed with an LLC because you can also opt to be taxed as an S corporation or a C corporation if it works to your advantage. Some LLCs elect S corporation taxation to save on self-employment taxes, while others elect C corporation taxation for the wider range of tax benefits or other benefits.
You’ll also want to investigate any special write-offs your LLC may be able to claim.
Even though a traditional LLC already has pass-through taxation, it may still benefit from electing S corp status. It takes a bit of explanation, but it could mean saving thousands of dollars for certain LLCs.
The members of a standard LLC are considered self-employed. They’re compensated by receiving their share of profits from the LLC, but they can’t be employed by the LLC. Being self-employed means paying self-employment taxes (the taxes earmarked for Social Security and Medicare) on all profits they receive from the LLC. This is more than the taxes they’d pay when working for someone else because their employer would pay half of them.
When the members elect S corp status, though, they can be compensated in two ways, by receiving their share of the profits and by being paid as an employee. Once they do that, they only pay those Social Security and Medicare taxes on their salary and not the profits they receive. (Of course, LLC members still must pay income and other applicable taxes on their profits.) This can add up to a lot for certain profitable LLCs.
One caveat to this is that the IRS expects you to pay yourself a “reasonable salary” as an employee of the LLC. Otherwise, you could pay yourself an annual salary of $1 and avoid contributing anything to Social Security and Medicare. The IRS generally considers “reasonable” to be something similar to what others in your field are earning.
If you’re looking to form an LLC of your own or need help navigating its tax situation, consider reaching out to us. We have business formation services and an extensive suite of solutions, including our Money app, which helps you track deductions and prepare for tax time. Everything has been carefully designed from the ground up to simplify business operations to help you start, manage, and grow your business.
So while understanding LLC taxation can be complicated, you don’t have to navigate it alone. Get started today by calling 1-844-493-6249 or visiting our Start an LLC page for more info.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Some of the key tax benefits of having an LLC include avoiding double taxation and having control over how you’re taxed.
By default, an LLC is a pass-through entity, meaning the business itself doesn’t pay federal income taxes on its profits. The profits are only taxed when they’re distributed to the individual members.
If you’re operating a single-member LLC, you can simply take a draw or distribution, and you don’t need to pay yourself a salary. In fact, you can’t pay yourself as an employee of the LLC unless you’re filing as a corporation. If you’re a member of a multi-member LLC and it’s structured like a partnership, you can also pay yourself by taking a distribution or draw. How, how much, and how often you can take a draw will depend on what you and the other members have established in your LLC’s operating agreement.
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