Learn the basic essentials to filing taxes for a multi-member LLC.
Multi-member LLC taxes — a tedious but essential aspect of running a business. Even if you’ll hire an accountant to handle your business taxes, it’s a good idea to understand the basics of multi-member LLC taxation. In this guide, we’ll cover the essentials to multi-member LLC taxes, including how taxation works, how to file your taxes, and more.
By default, a multi-member limited liability company (LLC) is taxed as a partnership, meaning they’re a pass-through entity for federal income tax purposes. The LLC itself doesn’t pay taxes; the members do by reporting the income they receive from distributions on their individual returns. This is different from a typical corporation, in which profits are taxed at both the business level and again at the individual owner level.
Even though a multi-member LLC itself isn’t a taxable entity by default, the LLC does still file an informational return (usually at both the state and federal levels). These informational returns usually describe the profits, losses, and deductions the LLC experienced throughout the year. They also explain how much profit was distributed to each member.
The members corroborate the numbers filed on the informational return when they file their personal taxes.
Business entity taxes for a single-member LLC (an LLC with only one member) are a little bit different than a multi-member LLC. Both LLCs are subject to pass-through taxation by default and pay personal income tax rates. But a single-member LLC is considered to be a “disregarded entity” for federal income tax purposes.
An SMLLC doesn’t file its own tax return; its owner simply reports any business income on their personal tax return. That’s because even though an SMLLC is a separate legal entity from its owner for liability purposes, it’s indistinguishable for tax purposes.
How you’ll file your taxes ultimately depends on what taxation structure you elect (or don’t elect). If you’re taxed as a partnership — the default status for federal tax purposes — then you’ll submit Form 1065, the U.S. Return of Partnership Income. This is just an informational report; the form with actual federal income taxes due is Schedule K-1 (1065). Each business partner will complete this section on their personal income tax return.
Typically, this approach repeats on the state level (with slightly different forms in each state). Some states, however, have a dedicated business income tax or partnership income tax to pay, even for pass-through entities. Every state’s business taxes are different, so we recommend enlisting the help of a local tax professional to cover all your bases.
To avoid underpayment fees or late fees, the IRS recommends making estimated payments once a quarter based on your projected income for the year. They’re a bit like deposits for your income taxes (or the income an employer would make tax withholdings from your paycheck). You’ll also be responsible for employment taxes, such as Social Security, Medicare, and so on.
There are a few ways you can reduce your tax bill. Beginning in 2018, the IRS introduced the Qualified Business Income Deduction. This deduction allows many small business owners to deduct 20% of their business income each year. It’s available regardless of whether you itemize or take the standard deduction.
Like any business, you can also write off certain costs, such as supplies for your business, mileage you travel for business purposes, advertising costs, and more. If you pay for your own insurance plan or take a training course, you can probably deduct those costs, too. You might even be able to make a compensation deduction for some of the wages and benefits you extend to your employees.
If you choose to take these deductions, be sure to keep good records of your receipts and be mindful of deduction limits. We also recommend hiring a business tax expert to assist with your taxes. For even more small business tax insights, check out our tax tips guide.
Pass-through taxation as a partnership is the default tax status for a multi-member LLC. However, if you elect a different tax structure like a C corporation or S corporation, your tax forms will look different.
LLCs taxed as C corporations file and pay taxes on a corporate tax return (Form 1120), while the owners report any income they receive from dividends on their personal returns. This results in double taxation of the business profits. However, corporate structures have more business tax credit options to take advantage of.
LLCs taxed as S corporations have very similar tax treatment to partnerships; the tax burden passes through to the members. But the forms are slightly different. S corporations use Form 1120-S instead. Make sure you use the correct tax forms for your taxation structure!
So, why would an LLC that already has pass-through taxation want to be taxed as an S corp? It has to do with potential savings on self-employment taxes (the taxes earmarked for Social Security and Medicare).
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 (about 15.3%) 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 part 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 self-employment taxes on their salary and not the profits they receive. (Of course, this is only for self-employment taxes; LLC members still must pay income and other applicable taxes on their profits.) This can add up to quite 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.
One of the biggest tax benefits of a multi-member LLC is simply that an LLC offers so many taxation options. While you can’t avoid taxes entirely, you can elect the tax status that creates the lowest possible tax burden for your unique business. For some multi-member LLCs, that benefit means avoiding the double taxation of a corporation and often higher corporate tax rates. But other multi-member LLCs might find it helpful to reduce self-employment taxes by filing as an S corporation or C corporation instead.
The luxury is that you can choose what best fits your needs. And, if your business needs change later on, you can change your taxation status.
At ZenBusiness, with love to help entrepreneurs take away some of the guesswork to running their business. Whether you need help forming your multi-member LLC, creating an operating agreement, or maintaining a registered agent, we can help. Our ZenBusiness Money App can also help you easily track invoices, expenses, and all the financial data you’ll need at your fingertips to keep taxes simple.
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.
Single-member LLCs or multi-member LLCs aren’t inherently better than each other; which choice is best depends on what your business needs are. The advantage to a multi-member LLC is that the creativity (and finances) of multiple entrepreneurs come together. But single-member LLC owners enjoy complete business autonomy by operating alone.
In a few states, courts have ruled unfavorably against single-member LLCs, treating them like sole proprietorships and dismantling their personal liability protection. But in most states, single-member LLCs are just as secure as multi-member LLCs.
It depends on what your operating agreement says. Members of a multi-member LLC get paid through distributions. But when those distributions happen — and what share of profits each member receives (called your distributive share) — is dictated completely by the operating agreement. Read more about how to pay yourself from an LLC.
Often, multi-member LLCs can elect S corporation status, and many do in order to reduce their tax burden for Social Security and Medicare. But they have to meet the IRS criteria to do so. That means the LLC can’t have more than 100 members, all of which must be U.S. citizens, permanent residents, and/or certain trusts and estates (not other entities like partnerships or corporations).
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